## 1. A Downside Scenario of Stagnation in the Euro Area

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### Context: cyclical recovery and near-term outlook
- Recovery resumed after mid-2014 weakness, picking up late 2014 and continuing in 2015 driven by domestic demand.
- Private consumption remained robust; fixed investment expanded moderately.
- Among large economies: Germany grows slightly above 1½ percent; Spain rebounding strongly; Italy emerging from three years of recession; activity in France picked up at beginning of 2015.
- Growth projection: rise to 1.5 and 1.7 percent in 2015–16.

### Inflation and labor market developments
- HICP inflation in June was 0.2 percent (y/y); core inflation around 0.8 percent.
- Inflation path: close to zero in 2015, rising to 1.1 percent in 2016, reflecting an output gap of 2¼ percent of GDP.
- Rebound in oil prices since March helped return inflation to positive territory after early 2015 deflation.
- Labor costs continued to rise, driven mainly by higher wages.
- Low inflation is pushing up real rates; real interest rates (10-year government bond yield, deflated by CPI) are correlated with total net debt (net debt measured as percent of GDP).

### Drivers supporting the upturn
- Nearly 50 percent decline in USD oil prices through early 2015 lifted consumer and business spending.
- ECB monetary policy actions, including QE via the expanded asset purchase program (APP), boosted confidence, improved financial conditions, and reduced financial fragmentation.
- Euro in June about 7 percent weaker in nominal effective terms compared to 2014—expected to boost exports through 2016 given lagged pass-through.
- Fiscal stance projected broadly neutral in 2015 and 2016 after substantial adjustment through 2013.

### External position and intra-euro-area imbalances
- Current account remained in surplus in 2014 even as real imports picked up strongly.
- Euro area external position in 2014 broadly consistent with medium-term fundamentals.
- REER depreciation in 2015 beneficial for the cycle but now moderately weaker than level consistent with medium-term fundamentals.
- Debtor countries’ current accounts improved mainly via import compression; creditor countries (Germany and the Netherlands) saw large surpluses continue to grow.
- Further rebalancing requires addressing excess saving and weak investment in creditor countries and improving competitiveness in debtor countries.

### Risks, recent events, and contagion management
- Risks include: lingering weakness and low inflation; potential slowdown in emerging markets; geopolitical tensions; financial market volatility.
- Developments in Greece increased volatility and uncertainty: sovereign spreads widened for some euro area economies; Bund yields fell; equities—especially bank shares—fell; euro weakened moderately.
- Addition of tools such as QE, OMT and TLTROs has reduced spillover impact versus earlier years, but Greece remains a key uncertainty.
- Policy-makers should be ready to deploy and adapt the full arsenal of instruments; the ECB should ensure banks’ access to ample liquidity and orderly sovereign debt markets.
- If financial conditions tighten significantly, ECB should consider further loosening monetary policy through expansion of its asset purchase program.

### Structural and institutional reform priorities (policy recommendations)
- Strengthen monetary union and European firewalls:
  - Fully sever bank-sovereign links through a common deposit insurance scheme with a fiscal backstop.
  - Build a larger and fully funded Single Resolution Fund (SRF).
  - Enable easier access to direct bank recapitalization from the ESM.
- Underpin greater risk-sharing with a strengthened fiscal and structural governance framework; may require Treaty changes.
- Repair bank, corporate, and household balance sheets to enhance monetary transmission.
- Use fiscal space within the SGP framework and fiscal rebalancing to support demand and promote structural reforms; in an adverse scenario, invoke the systemic escape clause in the SGP to provide near-term demand support while strengthening medium-term fiscal commitments.
- Restrict guarantee-based insurance products by bringing minimum returns in line with current interest rates and encourage alternative long-term investments subject to supervision; some vulnerable insurers may need additional capital and reserves before Solvency II comes into force in 2016.
- Accelerate structural reforms to spur investment, productivity and competitiveness and advance intra-euro-area rebalancing.

### Outlook and key projections (medium term)
- Growth of only about 1.6 percent expected over the medium term.
- Potential growth averaging around 1 percent.
- Output gap would close around 2020 with unemployment still near nine percent and inflation reaching 1.7 percent.
- Per capita income gap with the U.S. is now the largest since the start of EMU and projected to widen further.

### Drivers of the subdued medium-term outlook
- Insufficient demand:
  - Business investment lags and remains well below pre-crisis levels due to weak demand, high corporate debt, policy uncertainty, and tight credit.
  - Overall unemployment has begun to fall but remains above 11 percent, with long-term and youth unemployment near historic highs.
  - Fiscal policy broadly neutral and not providing offsetting support.
- Weak balance sheets:
  - ECB assessment: banks raised capital but NPLs continued to rise, reaching systemic levels in some countries.
  - High NPLs and debt have held back bank lending and investment.
- Low and divergent productivity:
  - Structural reform progress piecemeal and uneven.
  - Productivity below pre-crisis levels and lags the U.S., notably in information technology and professional services.

### Downside scenario of stagnation (Box 1) — scenario and illustrative impacts
- Scenario description:
  - A modest confidence shock lowering private investment, combined with expectations of lower inflation at the zero lower bound, would keep real interest rates high.
  - For high public debt countries, risk premia could rise, amplifying the shock and raising the risk of a debt-deflation spiral.
- Illustrative model results:
  - Euro area output could be nearly 2 percent lower by 2020.
  - Euro area current account would increase by 0.7 percent of GDP.
  - Real imports would contract by 3 percent.
  - Other EU countries’ exports would fall by 1.2 percent.
  - Rest of the world’s exports would decline by 0.6 percent.
- Distribution and fiscal effects:
  - Higher real interest rates in countries with weaker balance sheets.
  - Fragmentation progress would reverse; public debt would increase more in high debt countries due to lower fiscal balances and nominal output.
  - “Bad” internal rebalancing: current accounts in high debt countries would rise due to import compression; lower inflation would worsen external imbalances via lower prices and employment.

### Authorities’ views (ECB, EC, common)
- ECB: More optimistic on recovery and QE effects via credit conditions, confidence, inflation expectations, and exchange rate; expects inflation to rise more quickly with closing output gap but notes very high structural unemployment.
- EC: Emphasized benefits from EFSI to promote investment; viewed low growth and inflation in the euro area as a serious threat to other economies.
- Common views: Authorities largely shared staff views on risks; euro area has greater capacity to deal with Greece risks given instruments (OMT, QE, ESM); common deposit guarantee and fiscal backstop lack wide support. Authorities concurred potential growth could be only around 1 percent, with demographics weighing on growth.

### Policy recommendations — a collective, concerted commitment
- Four key pillars:
  - Continuing demand support.
  - Cleaning up bank balance sheets.
  - Accelerating structural reforms.
  - Strengthening economic governance to incentivize reforms.
- Rationale:
  - Combined actions would be self-reinforcing, strengthen resilience, and generate a large growth dividend with positive global spillovers.
  - Would boost monetary easing effectiveness, limit crowding out from fiscal expansion, address weak balance sheets, and increase productivity and investment via structural reforms.

### Upside scenario of demand support and comprehensive reforms (Box 2) — components and simulated outcomes
- Scenario components:
  - Monetary easing: current interest rate policy through 2020 and QE through September 2016.
  - Fiscal space within the SGP: 0.6 percent of euro area GDP comprising:
    - 0.3 percent of euro area GDP: room under countries’ Medium-Term Objectives (MTOs).
    - 0.2 percent of euro area GDP: SGP flexibility for structural reforms for a few qualifying countries.
    - 0.1 percent of euro area GDP: windfalls from lower interest payments due to QE for one-off investments or structural reforms for a few countries already meeting their MTOs.
  - Centralized investment: increase in private investment of 0.2 and 0.8 percent of euro area GDP in 2015 and 2016 (equivalent to 1/3 of targeted EFSI projects).
  - Clean-up of balance sheets: simulated decline in corporate borrowing rates by 80 basis points in Italy, 25 basis points in Germany and France, and 50 basis points in the rest of the euro area.
  - Structural reforms: gradual TFP increases of about 0.1 percent in 2015, 0.5 percent in 2017, and 0.9 percent in 2020.
- Simulated macro outcomes:
  - Real growth increase of 1.3 and 1.4 percentage points to 2.7 and 3.0 percent for 2015 and 2016.
  - HICP inflation rise to 0.6 and 2.1 percent in 2015 and 2016.
  - Output gap closed by end-2016, about four years faster than baseline.
  - Unemployment 0.8 percentage point lower than baseline by 2016.
  - Current account surplus would decline by 0.4 percent of GDP in 2015 and by 0.9 percent of GDP in 2016.

### Monetary policy implementation facts (QE program)
- Eurosystem purchases: more than €193 billion of sovereign and supranational debt purchased so far.
- Expansion of Eurosystem balance sheet by about 14 percent.
- About €44 billion of public sector securities purchases expected per month until at least September 2016.

### External rebalancing within the euro area (simulation)
- German current account surplus would decline by 1.3 percent of GDP in 2016.
- Comparative changes: Italy (-0.4 percent of GDP), France (-0.4 percent of GDP); other countries with negative external debt positions would see much smaller declines.

### QE and ECB policy guidance — findings and stance
- Trend decline in inflation expectations reversed but remain below historical average and ECB’s medium-term price stability objective.
- Early signs of turnaround in lending exist, but credit and inflation impacts will take time due to weak bank balance sheets and corporate deleveraging.
- Staff supports full implementation of QE until at least September 2016 and readiness to extend if inflation and expectations fail to pick up.
- Continued clear communication by the Governing Council recommended.
- ECB may flexibly alter composition, amount, and timing of purchases if market volatility tightens financial conditions and undermines objectives.

### Enhancing flexibility and collateral availability in the asset purchase program
- Concerns: restriction on sovereign bond purchases below the negative deposit rate, single issuer and exposure limits may create sovereign bond shortages and collateral availability issues.
- Eligible national agency debt available for purchase outside core economies: 4.7 percent.
- Recommendations:
  - Widen eligibility of agency debt; increase purchases of supranational debt; relax issue/issuer limits and private sector asset purchase criteria.
  - Develop a common securities lending framework and harmonize securities lending under the PSPP across NCBs.
  - ECB decided securities would be available for lending in a harmonized manner across NCBs and the ECB.

### Macroprudential policies and financial stability
- Main systemic risks: abrupt reversal of global risk premia, weak profitability for banks and insurers, developments in Greece, slow credit growth, early-stage housing recovery.
- Recommended toolkit:
  - Raise capital buffers; stricter requirements on capital, liquidity, large exposures, and risk weights.
  - National measures (e.g., loan-to-value limits) to dampen real estate lending.
  - Intensify macroprudential surveillance of non-bank financial institutions in coordination with the ESRB.
  - SSM to consider MoUs with NCAs for AML/CFT cooperation.

### Breaking the bank-sovereign link and resolution frameworks
- BRRD resolution framework and bail-in regime expected operational from 2016.
- SRF financial capacity limited: €55 billion relative to euro area banking sector size: €22 trillion.
- SRB to be fully operational in January 2016.
- Policy recommendations:
  - Accelerate SRF funding and mutualization; expand SRF capacity.
  - Relax preconditions for ESM direct recapitalization (bail-in requirement of at least 8 percent seen as too high) and consider raising the €60 billion ceiling on ESM direct recapitalization capacity.
  - Establish a pan-European Deposit Guarantee Scheme with a possible common fiscal backstop.

### Life insurers and low interest rate risks
- Low investment returns fell below minimum return guarantees for many life insurers; problem concentrated among small and mid-size insurers.
- Less than half of EU countries have insurance guarantee schemes.
- Recommendations:
  - Reassess viability of guarantee-based products.
  - Adopt prudential measures for asset-liability matching and diversification.
  - Vulnerable insurers may need to raise capital before Solvency II comes into force next year and might allocate less profit to policyholders.
  - Harmonize national policy holder protection schemes and unify resolution frameworks.

### Delivering fiscal support within the SGP
- Aggregate available fiscal space under countries’ MTOs and lower interest rates totals around 0.4 percent of euro area GDP.
- Centralized investment through EFSI leverages €21 billion in public funds and guarantees to catalyze €315 billion in private investment.
- Recommendations:
  - Countries with fiscal space under their MTOs should use it; others should save interest windfalls to reduce debt and meet fiscal targets.
  - Pursue growth-friendly fiscal rebalancing: lower marginal taxes on labor and capital, financed by cuts to unproductive spending or base-broadening.
  - Use SGP flexibility for critical structural reforms and investments; EC should identify qualifying reforms and investments.
  - Ensure high-quality project selection for EFSI.

### Balance sheet repair and NPL resolution — findings and recommendations
- High NPLs hinder lending and recovery; countries with high NPLs show weakest credit recovery.
- NPL disposal illustrative analysis (aggregate sample covering almost 90 percent of institutions under direct ECB supervision):
  - Aggregate capital released: between €13–€42 billion for haircut range between zero and 5 percent.
  - Potential new lending unlocked: between €167–€522 billion (1.8–5.6 percent of sample countries’ GDP), conditional on demand.
  - Portugal, Italy, Spain, and Ireland benefit most in this stylized example.
- Recommendations for SSM-led approach:
  - Strengthen incentives for write-offs or debt restructuring; coordinate provisioning and collateral valuation; higher capital surcharges or time limits on long-held NPLs.
  - For banks with high SME NPLs adopt a “triage” approach with targets for NPL resolution and standardized criteria to identify nonviable firms.
  - Enhance insolvency and foreclosure systems; accelerate court procedures and encourage out-of-court workouts.
  - Jumpstart a market for distressed debt using national AMCs or a centralized AMC where appropriate, complying with EU State aid rules and market pricing.

### Box 3 — NPL Problem: policy implications and harmonization
- Harmonize capital definitions and regulatory treatment quickly, including treatment of Deferred Tax Assets (DTAs).
- DTAs count as regulatory capital today but are of doubtful loss-absorbing capacity; phased out over a 10-year transition to Basel III.
- ECB supervisory measures: NPL resolution a priority; subset of banks under enhanced monitoring; ECB to consider targets on restructured loans and urge NCAs to follow suit.
- AMCs would need to meet State aid rules; little political appetite for pan-European AMC due to heterogeneity of legacy assets.
- Harmonization of capital and liquidity will take time; ECB focused on harmonizing NPL definitions and supervisory implementation of the Single Rulebook.

### Box 4 — “Outcome-Based” Structural Reform Benchmarking
- Benchmarking approach:
  - Prioritize area-wide reforms with single market dimension; benchmarks should be concrete, measurable, under policymakers’ control, and linked to best practices.
  - EC and European Council to monitor and enforce progress.
- Example measurable indicators: time to enforce contracts; time to complete insolvency; time to obtain a business license; burden of tax compliance; labor tax wedge; differences between retail and wholesale electricity prices.
- Advantages: increased ownership, transparency, comparability, prioritization, and accountability.
- Challenges: operational difficulty in identifying measurable benchmarks fully under policymakers’ control; some indicators may not reflect reform progress.
- Staff appraisal:
  - Structural reforms urgently needed: labor market reforms to reduce duality; product and service sector reforms; faster implementation of the Services Directive; improvements to insolvency regimes; deeper single market integration.
  - Governance improvements: outcome-based benchmarks, selective EU legislation, better use of SGP flexibility, independent structural council at EU level, national productivity councils.
  - Fiscal framework recommendations: focus on single fiscal anchor (public debt-to-GDP) and single operational target (expenditure growth rule, possibly with debt correction mechanism).

### Current account, REER, and capital flows (key statistics and assessments)
- Cyclically-adjusted current account in 2014 estimated surplus of about 1.9 percent of GDP.
- CA was 2.2 percent of GDP in 2013.
- CA norm of 2.0 percent of GDP reflects adverse demographics and weak medium-term growth prospects.
- CA expected to strengthen in 2015 by nearly one percent of GDP, reflecting:
  - improvement in net oil balance by about 0.7 percent of GDP,
  - some competitiveness gains,
  - continued weak domestic demand.
- CPI-based REER fell by 10 percent as of May 2015 compared with its 2014 average.
- Staff assesses 2014 REER consistent with fundamentals (REER gap between -5 to 5 percent); 2015 depreciation consistent with cyclical outlook and need for monetary accommodation.
- Financial account deficit in 2014 driven by bank-related and portfolio debt outflows, partially offset by portfolio equity inflows.
- Data vintage as of June 2, 2015; revision since then indicates current account balance in 2014 is 2.1 percent of GDP.

### Country-specific structural reform highlights and staff recommendations (selected)
- France: reform government spending, labor markets, competition in services; staff recommends broad spending reviews, raise effective retirement age, tighten caps on local taxes and borrowing, reform minimum wage formula, and liberalize regulated professions.
- Germany: increase labor force participation, productivity and competition in services; staff recommends lower tax wedge for low-skilled and women, improve child care provision, deregulate professional services.
- Greece: improve labor market flexibility, competition, business environment; staff recommends no backtracking on recent labor market reforms, keep subminimum wage given youth unemployment at 26 percent.
- Portugal: alleviate impediments to competitiveness and growth; staff recommends upgrading public services, reduce energy and transport costs, strengthen market integration.
- Spain: address labor market duality, boost productivity, improve SME finance; staff recommends build on 2012 labor reform, address regulatory burdens, facilitate private deleveraging.
- Italy: raise public sector efficiency, improve civil justice, labor market flexibility, competition; staff recommends implement public administration reform, judicial efficiency measures, fully implement Jobs Act and competition law.

### Appendix highlights and statistical improvements
- Transition to ESA 2010 complete; BPM6 transition complete.
- Flash quarterly GDP estimates at T+30 days under consideration.
- FIGARO project to establish EU multi-country input-output tables.
- Security-by-security holdings dataset in place since 2013; timeliness to be enhanced to 55 days from 2016.
- Insurance corporations’ quarterly balance sheet reporting from May 2016 (data as at 2016Q1); new statistics to be released end-2016.
- Harmonized granular credit data reporting foreseen in early 2018.
- MMSR requires daily money market transaction reporting from April/July 2016 with ISO 20022 reporting instructions.
- SDR euro component interest rate changed on December 22nd 2014 to a three-month spot rate derived from a yield curve based on euro area central government bonds rated AA and above.

### Statement by Staff Representative — July 24, 2015 (Greece and market developments)
- Greek parliament passed reforms as basis for negotiations on a new ESM program; bridge financing approved; Greece met a July repayment to the ECB and cleared arrears to the Fund.
- ECB increased cap on ELA to Greek banks.
- Market outcomes: asset prices broadly returned to prior levels; 10-year German Bund yield fell to under 0.8 percent; euro trading more than 3 percent lower versus the U.S. dollar.
- Policy implications: new instruments and stronger banking union have limited contagion but further uncertainty possible; severing bank-sovereign links requires common deposit insurance with fiscal backstop, larger SRF, and easier ESM recapitalization access.

*Source: IMF staff report — "1. A Downside Scenario of Stagnation in the Euro Area."*

### 1. A Downside Scenario of Stagnation in the Euro Area ________________________________________ 12

### 1. A Downside Scenario of Stagnation in the Euro Area

### Context: cyclical recovery and near-term outlook
- The recovery continues after weakness through mid-2014, with growth picking up late 2014 and continuing in 2015, driven by domestic demand.  
- Private consumption remained robust, reflecting rising employment and real wages; fixed investment has expanded moderately.  
- Among large economies: Germany grows slightly above 1½ percent; Spain is rebounding strongly; Italy is emerging from three years of recession; activity in France picked up at the beginning of 2015.  
- Growth is projected to rise to 1.5 and 1.7 percent in 2015–16.

### Inflation and labor market developments
- HICP inflation in June was 0.2 percent (y/y); core inflation remained around 0.8 percent.  
- Inflation is expected to remain close to zero in 2015 before rising to 1.1 percent in 2016, reflecting a still large output gap of 2¼ percent of GDP.  
- After widespread deflation in early 2015, the rebound in oil prices since March has helped return inflation to positive territory.  
- Labor costs have continued to rise, led mainly by higher wages, albeit from low levels.  
- Low inflation is pushing up real rates, more in countries with higher debt burdens; real interest rates (10-year government bond yield, deflated by CPI) are correlated with total net debt (net debt measured as percent of GDP).

### Drivers supporting the upturn
- Nearly 50 percent decline in USD oil prices through early 2015 has lifted consumer and business spending.  
- ECB monetary policy action, including quantitative easing (QE) via the expanded asset purchase program (APP), has boosted confidence, improved financial conditions, and contributed to a reduction in financial fragmentation.  
- The euro in June was around 7 percent weaker in nominal effective terms compared to 2014, which should boost exports through 2016 given lagged pass-through.  
- After substantial fiscal adjustment through 2013, the euro area fiscal stance is projected to remain broadly neutral in 2015 and 2016.

### External position and intra-euro-area imbalances
- The current account remained in surplus in 2014 even as real imports picked up strongly.  
- Overall, the euro area’s external position in 2014 was broadly consistent with the level implied by medium-term fundamentals.  
- The REER depreciation of the euro so far in 2015 has been beneficial given the economic cycle, but the currency is now moderately weaker than the level consistent with medium-term fundamentals.  
- Current account balances among debtor countries have improved, but rebalancing has failed to take place among creditor countries; large current surpluses of Germany and the Netherlands continued to grow and moved farther away from levels implied by medium-term fundamentals.  
- Further rebalancing will require addressing excess saving and weak investment in creditor countries while improving competitiveness of debtor countries.

### Risks, recent events, and contagion management
- Risks are more balanced than in recent years but include: lingering weakness and low inflation; potential slowdown in emerging markets; geopolitical tensions; financial market volatility.  
- Managing potential contagion from evolving developments in Greece will require timely and effective policy actions. Recent market reaction to the breakdown in talks was relatively contained but increased volatility and uncertainty: sovereign spreads widened among some euro area economies; Bund yields fell; equities, especially bank shares, fell; and the euro weakened moderately.  
- The addition of tools such as QE, OMT and TLTROs has reduced spillover impact compared to a few years ago, but the situation in Greece remains fluid and a key source of uncertainty.  
- To manage contagion risks, policy-makers should stand ready to deploy, and if necessary adapt, the full arsenal of available instruments; the ECB should ensure banks continue to have access to ample liquidity and maintain orderly conditions in sovereign debt markets. If financial conditions tighten significantly, the ECB should consider further loosening monetary policy through an expansion of its asset purchase program.

### Structural and institutional reform priorities (policy recommendations)
- Accelerate steps to strengthen the monetary union and European firewalls, including:
  - Fully sever bank-sovereign links through a common deposit insurance scheme with a fiscal backstop.  
  - Build a larger and fully funded Single Resolution Fund (SRF).  
  - Enable easier access to direct bank recapitalization from the ESM.  
- Underpin greater risk-sharing with a strengthened fiscal and structural governance framework, which could require possible Treaty changes.  
- Repair bank, corporate, and household balance sheets to enhance monetary transmission.  
- Use fiscal space within the SGP framework and fiscal rebalancing to support demand and promote structural reforms; in an adverse scenario, invoke the systemic escape clause in the SGP to provide near-term demand support while strengthening medium-term fiscal commitments.  
- Restrict the use of guarantee-based insurance products by bringing minimum returns in line with current interest rates and encourage alternative long-term investments to spur diversification subject to proper supervision; some vulnerable insurers may need additional capital and reserves before Solvency II comes into force in 2016.  
- Accelerate structural reforms to spur investment, productivity and competitiveness and advance intra-euro-area rebalancing.

*Source: IMF staff report — "1. A Downside Scenario of Stagnation in the Euro Area."*

### 9.      Only tepid growth is expected over the forecast horizon. Despite the cyclical upturn,

### _cr15204 - 9.      Only tepid growth is expected over the forecast horizon. Despite the cyclical upturn,

### Outlook and key projections
- Growth of only about 1.6 percent is expected over the medium term.
- Potential growth averaging around 1 percent.
- The output gap would close around 2020 with unemployment still near nine percent and inflation reaching 1.7 percent.
- The per capita income gap with the U.S. is now the largest since the start of EMU and is projected to widen further.

### Drivers of the subdued medium-term outlook
- Insufficient demand
  - Business investment continues to lag the cycle and remains well below pre-crisis levels due to weak demand, high corporate debt, policy uncertainty, and tight credit.
  - Overall unemployment has begun to recede but remains above 11 percent, with long-term and youth unemployment near historic highs.
  - Fiscal policy is broadly neutral and is not providing offsetting support.
- Weak balance sheets
  - The ECB’s comprehensive assessment found that banks had raised capital but NPLs continued to rise, reaching systemic levels in some countries.
  - High levels of NPLs and debt have held back bank lending and investment, limiting the pass-through of easier financial conditions.
- Low and divergent productivity
  - Progress on structural reforms has been piecemeal and uneven across countries.
  - Productivity remains well below pre-crisis levels and lags the U.S., especially in information technology and professional services.

### Downside scenario of stagnation (Box 1)
- Scenario description
  - A modest confidence shock lowering private investment, combined with expectations of lower inflation at the zero lower bound, would keep real interest rates high.
  - For high public debt countries, risk premia could rise, amplifying the shock and raising the risk of a debt-deflation spiral.
- Illustrative impacts (model results)
  - Euro area output could be nearly 2 percent lower by 2020.
  - The euro area current account would increase by 0.7 percent of GDP.
  - Real imports would contract by 3 percent.
  - Other EU countries’ exports would fall by 1.2 percent.
  - The rest of the world’s exports would decline by 0.6 percent.
- Distribution and fiscal effects
  - The impact would vary across countries with higher real interest rates in countries with weaker balance sheets.
  - Fragmentation progress would reverse and public debt would increase more in high debt countries due to lower fiscal balances and nominal output.
  - “Bad” internal rebalancing: current accounts in high debt countries would rise due to import compression; lower inflation would worsen external imbalances by forcing adjustment through lower prices and employment.

### Authorities’ views
- The ECB
  - More optimistic on the recovery’s strength and saw QE working via improved credit conditions, greater confidence, higher inflation expectations, and indirectly through the exchange rate.
  - More upbeat on inflation, expecting it to rise more quickly along with the closing of the output gap.
  - Highlighted the possibility that inflation could rise to the price stability objective, but with very high structural unemployment.
- The European Commission (EC)
  - Saw greater benefits from the European Fund for Strategic Investments (EFSI) to promote investment.
  - Considered low growth and inflation in the euro area as a more serious threat to other economies than temporary weakness in the euro.
- Common views
  - Authorities largely shared staff views on sources of risks, with the ECB seeing risks as slightly tilted to the downside.
  - The euro area now has greater capacity to deal with potential risks from Greece given enhanced instruments (e.g., OMT, QE, and the ESM), though a common deposit guarantee scheme and fiscal backstop for the banking union do not yet command wide support.
  - Authorities concurred on the subdued medium-term outlook and the likelihood that potential growth could be only around 1 percent, noting demographics are weighing on potential growth.

### Policy recommendations — a collective, concerted commitment
- Four key pillars for a concerted commitment to lasting growth:
  - Continuing demand support.
  - Cleaning up bank balance sheets.
  - Accelerating structural reforms.
  - Strengthening the economic governance framework to incentivize reforms.
- Rationale
  - Action in these areas would be self-reinforcing, strengthen the monetary union’s resilience to shocks, and generate a large growth dividend for Europe and positive spillovers for the global economy.
  - Combined policies would boost the effectiveness of monetary easing, limit crowding out from fiscal expansion, address weak balance sheets, and increase productivity and investment via structural reforms.

### Upside scenario of demand support and comprehensive reforms (Box 2)
- Scenario components
  - Monetary easing: current interest rate policy continues through 2020 and QE through September 2016.
  - Fiscal space within the SGP: 0.6 percent of euro area GDP, comprising:
    - 0.3 percent of euro area GDP: room under countries’ Medium-Term Objectives (MTOs).
    - 0.2 percent of euro area GDP: SGP flexibility for structural reforms for a few qualifying countries.
    - 0.1 percent of euro area GDP: windfalls from lower interest payments due to QE for one-off investments or structural reforms for a few countries already meeting their MTOs.
    - Growth-friendly fiscal rebalancing for countries with limited fiscal space to lower the labor tax wedge by two percentage points, financed by base-broadening measures.
  - Centralized investment: an increase in private investment of 0.2 and 0.8 percent of euro area GDP in 2015 and 2016, equivalent to 1/3 of the targeted EFSI projects.
  - Clean-up of bank and corporate balance sheets: simulated decline in corporate borrowing rates by 80 basis points in Italy, 25 basis points in Germany and France, and 50 basis points in the rest of the euro area.
  - Structural reforms: gradual implementation could increase TFP by about 0.1 percent in 2015, 0.5 percent in 2017, and 0.9 percent in 2020; France, Italy, and Spain would enjoy the largest gains.
- Simulated macro outcomes
  - Real growth for the euro area would increase by 1.3 and 1.4 percentage points to 2.7 and 3.0 percent for 2015 and 2016.
  - HICP inflation would rise to 0.6 and 2.1 percent in 2015 and 2016.
  - The output gap would close by the end of 2016, about four years faster than in the baseline.
  - Unemployment would be 0.8 percentage point lower than in the baseline by 2016.
  - The current account surplus would decline by 0.4 percent of GDP in 2015 and by 0.9 percent of GDP in 2016, generating positive external spillovers, especially to other EU countries.

### Monetary policy implementation facts (QE program)
- Eurosystem purchases and balance sheet
  - So far the Eurosystem has purchased more than €193 billion of sovereign and supranational debt.
  - Expanding the Eurosystem’s balance sheet by about 14 percent.
  - About €44 billion of public sector securities purchases expected per month until at least September 2016.

*Source: IMF staff estimates.*

### 0.4 percentage point in 2015 and 0.6 percentage point 2016. Comprehensive policies could also help

### _cr15204 - 0.4 percentage point in 2015 and 0.6 percentage point 2016. Comprehensive policies could also help

### External rebalancing within the euro area
- Simulation result: the current account surplus in Germany would decline by 1.3 percent of GDP in 2016.
- Comparative changes: Italy (-0.4 percent of GDP), France (-0.4 percent of GDP), and other countries with negative external debt positions would experience much smaller declines.

### FSGM simulation highlights (growth, inflation, current account)
- FSGM simulations on GDP growth and inflation present scenarios for 2015–2017 with policy layers:
  - Labor and Product Market Reforms
  - Improved Credit Conditions
  - Fiscal Policies
  - Current Policies (WEO Apr 2015)
  - Overall impacts reported for 2015, 2016, 2017 in percent.
- FSGM simulations on current account reported in percent of GDP for 2015–2017 under the same policy layers.

### QE and ECB policy guidance
Findings
- Trend decline in inflation expectations has been reversed but remains below the historical average and the ECB’s medium-term price stability objective.
- Early signs of a turnaround in lending exist, but previous QE episodes suggest credit and inflation impacts will take more time because of weak bank balance sheets and corporate deleveraging.

Policy recommendations and operational stance
- Staff strongly supports the ECB’s intention to implement QE fully until at least September 2016, and to stand ready to extend the program if inflation and inflation expectations fail to pick up as expected.
- Continued clear communication of the Governing Council’s intentions is recommended to mitigate excessive market volatility and reinforce commitment to price stability.
- The ECB intends to “look through” temporary market volatility and continue announced asset purchases until a sustained adjustment in inflation is achieved.
- The ECB may flexibly alter composition, amount, and timing of purchases if market volatility tightens financial conditions and undermines objectives.

### Enhancing flexibility and collateral availability in the asset purchase program
Findings
- Restriction on sovereign bond purchases below the negative deposit rate combined with single issuer and exposure limits raise concerns about possible shortages of sovereign bonds and availability as collateral.
- The list of eligible national agency debt leaves a relatively small share available for purchase outside core economies: 4.7 percent.

Recommendations
- Expand flexibility in asset purchases by:
  - Widening eligibility of agency debt.
  - Increasing purchases of supranational debt.
  - Relaxing security issue/issuer limits and private sector asset purchase criteria (currently slightly more stringent than for public assets with similar risk).
- Develop a common securities lending framework:
  - Harmonize conditions for securities lending under the PSPP across NCBs.
  - Promote use of specialized securities lending agents across NCBs.
- ECB decided securities would be available for lending in a harmonized manner across NCBs and the ECB; price and other incentives could encourage dealers to borrow from NCBs first.

Statistics on eligible government debt (as of June 15, 2015)
- Total eligible (after deposit rate cap) and total eligible (after issue/issuer limits) shown in nominal EUR billions.
- Note: excludes bonds ineligible due to nominal yield below deposit facility rate (-20 bps).

### Macroprudential policies and financial stability
Findings
- If financial stability risks arise, macroprudential policies should be the first line of defense.
- Main systemic risks: abrupt reversal of global risk premia, weak profitability for banks and insurers, developments in Greece, slow credit growth, early-stage housing recovery.

Recommended macroprudential toolkit
- Raise capital buffers.
- Impose stricter requirements on capital, liquidity, large exposures, and risk weights.
- National measures such as loan-to-value limits to dampen real estate lending.
- Intensify macroprudential surveillance of non-bank financial institutions in coordination with the ESRB.
- SSM should consider MoUs with NCAs responsible for AML/CFT to formalize cooperation in identifying and mitigating AML/CFT risks.

### Breaking the bank-sovereign link and resolution frameworks
Findings
- BRRD resolution framework and bail-in regime expected to be operational from 2016.
- Single Resolution Fund (SRF) financial capacity limited: €55 billion relative to the size of the euro area banking sector: €22 trillion.
- SRB to be fully operational in January 2016.

Policy recommendations
- Accelerate schedule for SRF funding and mutualization of “national components” from the current eight-year transition period and expand SRF capacity.
- Relax preconditions for ESM direct recapitalization:
  - Current preconditions require bail-in of at least 8 percent of bank liabilities, followed by sovereign recapitalization (if necessary) to raise common equity tier 1 to 4.5 percent of liabilities—these are considered too high and should be relaxed.
  - Consider raising the €60 billion ceiling on ESM direct recapitalization capacity.
- Establish a pan-European Deposit Guarantee Scheme (DGS) to discourage liquidity ring-fencing; consider developing a common fiscal backstop to national DGSs, perhaps through the ESM.

### Life insurers and low interest rate risks
Findings
- Low investment returns have fallen below minimum return guarantees for many life insurers; past stress tests may understate insolvency risks from prolonged low rates.
- Problem concentrated among small and mid-size insurers.
- Less than half of EU countries have insurance guarantee schemes.

Recommendations
- Regulators should reassess the viability of guarantee-based products.
- Adopt prudential measures to improve asset-liability matching and diversification of long-term investments.
- Some vulnerable insurers may need to raise capital before Solvency II comes into force next year and might allocate less profit to policyholders.
- Harmonize national policy holder protection schemes and unify resolution frameworks to reduce contagion risk.

### Delivering fiscal support within the SGP
Findings
- Using fiscal space and flexibility within the SGP can support recovery and complement QE.
- Aggregate available fiscal space under countries’ MTOs and benefiting from lower interest rates totals around 0.4 percent of euro area GDP.
- Centralized investment through the EFSI leverages €21 billion in public funds and guarantees to catalyze €315 billion in private investment.

Recommendations
- Countries with fiscal space under their MTOs should use this space; countries without fiscal space should save interest windfalls to reduce debt and meet fiscal targets.
- Pursue growth-friendly fiscal rebalancing: lower marginal taxes on labor and capital, financed by cuts to unproductive spending or base-broadening measures.
- Use SGP flexibility (one-off and temporary deviations from MTOs) to support critical structural reforms; EC should identify qualifying structural reforms and investments.
- Ensure high-quality project selection for EFSI to support new, higher risk investments and remove regulatory barriers.

Authorities’ views
- Authorities emphasized upholding and strengthening SGP credibility and noted uneven fiscal distribution: countries with fiscal space are choosing not to use it.
- EC indicated eligibility conditions and safeguards will likely limit space for structural reforms and investment to qualify under SGP flexibility.
- EIB had approved several projects and the EFSI expected to be fully operational by autumn; investment committee to ensure additional, riskier projects are backed.

### Balance sheet repair and NPL resolution
Findings
- High NPLs are hindering lending and the recovery by weakening bank profitability and tying up capital.
- Countries with high NPLs have shown the weakest recovery in credit.
- Euro area: Non-Performing Loans by country shown as percent of total loans (2008 and 2014 or latest).

Recommendations for a centralized SSM-led approach
- Accelerate NPL resolution:
  - Strengthen incentives for write-offs or debt restructuring.
  - Coordinate with NCAs to have banks set realistic provisioning and collateral values.
  - Use higher capital surcharges or time limits on long-held NPLs.
  - For banks with high SME NPLs, adopt a “triage” approach: set targets for NPL resolution; standardized criteria to identify nonviable firms for quick liquidation and viable ones for restructuring.
  - Enhance banks’ NPL resolution tools and expertise.
- Improve insolvency and foreclosure systems:
  - Accelerate court procedures and encourage out-of-court workouts.
- Jumpstart a market for distressed debt:
  - Use national AMCs to purchase and dispose of NPLs quickly; a centralized AMC could provide economies of scale but must comply with EU State aid rules and purchase assets at market prices.
  - Where markets are limited, use a formula-based approach for transfer pricing.
  - European agencies (EIB, EIF) could support through structured finance, securitization, or equity involvement.

Key banking sector indicators referenced
- Core Tier 1 capital ratios (2008–2014) show rising but still lower ratios in selected economies.
- Credit growth remains contracting year-on-year as corporate deleveraging is slow.
- Bank profitability varies widely across countries; loan loss provisions have lagged behind asset quality deterioration in many cases.

*Source: IMF staff report (cr15204).*

### Box 3. The NPL Problem in the Euro Area and Its Macro-Financial Implications

### Box 3. The NPL Problem in the Euro Area and Its Macro-Financial Implications

### Impact of NPLs on bank performance and credit supply
- High NPLs erode bank profitability and hold back new lending, limiting the effectiveness of monetary policy.
- Rising asset impairments tie up capital through diminished retained earnings and higher provisioning requirements, restricting banks’ ability to support economic recovery.
- A deteriorating balance sheet raises a bank’s cost of capital, resulting in some combination of higher lending rates, reduced lending volumes, and increased risk aversion.
- Credit growth remains particularly slow in countries where banks report high levels of impaired assets.

### Illustrative NPL disposal analysis and potential capital and lending effects
- Scenario assumptions:
  - Banks reduce the current stock of NPLs (end-2014) by selling distressed loans to external investors.
  - Regulatory capital charge of loan books falls in proportion to the share of NPLs and their applicable credit risk weight.
  - Sale prices assumed: net book value (upper bound), or uniform haircuts to net book values of either five percent (mid-range), or 10 percent (lower bound).
  - Sale prices in practice would reflect expected foreclosure time and debt-enforcement regime strength.
- Reduction target:
  - NPLs reduced to historical average levels (between three and four percent of gross loan books).
- Aggregate capital relief and lending capacity (large sample of euro area banks covering almost 90 percent of institutions under direct ECB supervision; banks meet target CAR of 13 percent):
  - Aggregate capital released: between €13–€42 billion for a haircut range of between zero and 5 percent.
  - Potential new lending unlocked: between €167–€522 billion (1.8–5.6 percent of sample countries’ GDP), conditional on corresponding demand for new loans.
- Distributional note:
  - Capital relief varies significantly across euro area countries; Portugal, Italy, Spain, and Ireland benefit the most in this stylized example.

### Empirical links shown in staff calculations (figures and notes preserved)
- Interest income to gross loans reference: relative to average (6.0).
- Lending growth reference: relative to average (-1.2).
- Left graph: annual interest income to gross loans for over 100 euro area banks, relative to the annual average for banks with the same nationality, calculated over the period 2009–13.
- Right graph: annualized lending growth relative to average lending growth in the same country, using data from the European Banking Authority for a sample of more than 60 banks over the period 2010–13.
- Outliers excluded based on extreme values for lending growth, nonperforming loans and interest margins.
- Capital relief calculations based on bank-by-bank data from the EBA Transparency Exercise (2013).
- Capital relief chart: 2014 values expressed as Percent of GDP; calculations assume a 5 percent haircut with +/-5 percent variation noted.

### Policy implications and recommendations
- Harmonize capital definitions and regulatory treatment:
  - National differences in the definition of capital under transitional arrangements of the Capital Requirements Regulation (CRR) should be removed quickly to enhance regulatory consistency.
  - Regulatory treatment of Deferred Tax Assets (DTAs) should be harmonized in a way that does not encourage excessive de-risking.
  - Further work is required to close gaps between the CRR and Basel III rules regarding the treatment of leverage and liquidity risk.
- DTAs and goodwill concerns:
  - Banks, particularly in stressed economies, hold large amounts of DTAs and goodwill, which are of doubtful loss-absorbing capacity.
  - DTAs currently count as part of regulatory capital but are not loss-absorbing; their use as capital will be phased out over a 10-year transition to Basel III.
  - Some economies have introduced legislative changes enabling DTAs to be transformed into Deferred Tax Credits, which are not contingent on future profits and can be counted as capital regardless of whether the bank is profitable.
- ECB supervisory measures and constraints:
  - The ECB has made NPL resolution a policy priority and placed a subset of banks with elevated NPLs under enhanced monitoring.
  - To encourage resolution of NPLs, the ECB will consider setting targets on restructured loans to either convert them to performing or write them off, and urge NCAs to follow the same approach for less significant institutions.
  - The ECB is reviewing bank assets not covered under the asset quality review (AQR) and stressed the importance of improving national insolvency and foreclosure regimes.
  - The ECB cannot change IFRS accounting rules but will foster realistic provisioning and collateral valuation practices to encourage write-offs.
  - The ECB agreed with staff on the possibility of using prudential measures to set time limits or capital surcharges on long-held NPLs.
- Asset Management Companies (AMCs) and State aid:
  - National AMCs would need to meet EU State aid rules; appropriateness of an AMC depends on circumstances and asset composition (AMCs might work better for real estate than SME loans).
  - Little political appetite for a pan-European AMC given heterogeneity of legacy assets.
  - EU State aid rules require assets be sold at market prices; sales above market price could trigger bail-in of creditors under State aid rules and BRRD.
  - Where markets are very illiquid, a formula-based approach to determining market prices is possible.
- Harmonization timeline:
  - Harmonization of capital and liquidity will take time.
  - The ECB is focused on harmonizing definitions of NPLs (and capital) across countries, in coordination with the European Banking Authority, and on supervisory implementation of the Single Rulebook.
  - Some options and national discretions remain outside the ECB’s purview where transitional measures have been enacted under national laws.
- Prudential and structural complementarities:
  - Removing national differences in capital definitions and improving insolvency and foreclosure regimes would facilitate NPL resolution and strengthen bank loss-absorbing capacity.

*Source: _cr15204 - Box 3. The NPL Problem in the Euro Area and Its Macro-Financial Implications*

### Box 4. “Outcome-Based” Structural Reform Benchmarking

### Box 4. “Outcome-Based” Structural Reform Benchmarking

### How benchmarking would work
- Outcome-based structural reform benchmarks would increase the specificity of the reform agenda, and improve transparency and accountability in the application of the current framework.
- First step: the EU and member states would prioritize area-wide structural reforms.
- Benchmarks should be:
  - concrete,
  - measurable,
  - under the control of policymakers,
  - linked to regional and global best practices.
- The EC and European Council would monitor and enforce progress toward achieving these benchmarks.

### Which benchmarks (examples)
- Prioritize reforms with a single market dimension (e.g., a common market for services, capital, and energy) and reforms that improve the business climate and help eliminate intra-euro area gaps in productivity and competitiveness.
- Possible measurable indicators include:
  - time to enforce contracts,
  - time to complete insolvency,
  - time to obtain a business license,
  - burden of tax compliance,
  - the labor tax wedge,
  - differences between retail and wholesale electricity prices.
- Example of a directly policy-influenced benchmark: “reduce labor tax wedge to x percent in y years”.

### Advantages of outcome-based benchmarking
- Increased ownership because member states would decide benchmarks jointly.
- Benchmarks apply to all countries while allowing member states leeway in developing action plans to achieve targeted outcomes.
- Process could spur greater discussion on best methods to achieve economic outcomes.
- Improves prioritization of reforms, facilitates monitoring, and enables pre-emptive corrective action.
- Increases transparency by making performance gaps clearly visible and comparable across countries.
- Reduces excessive discretion and perceived uneven application of the governance framework, increases accountability, and levels the playing field across members.

### Challenges and limitations
- Operational difficulty identifying and quantifying specific benchmarks with all desired characteristics.
- Uncertainty surrounding links between some reforms and outcomes; some outcome targets may not be fully under policymakers’ control (e.g., targets on employment rates such as those in the Europe 2020 strategy).
- Indicators may not accurately reflect reform progress.
- Better enforceable benchmarks are those directly influenced by policy (illustrated by the labor tax wedge example).

### Authorities’ views (summary of paragraphs 52–55)
- Enhanced economic governance is desirable, but progress is likely to be made in stages; near-term efforts should improve the current framework without Treaty change.
- Authorities broadly agreed with principles of greater ownership, specificity, transparency, independent evaluation, and accountability.
- The EC noted identifying appropriate outcome-based benchmarks could be operationally difficult, particularly identifying measurable indicators under the control of country authorities that can deliver desired outcomes.
- More consistent and transparent application of the existing structural reform governance framework, including the MIP, could strengthen credibility and compliance.
- Limits to how much legislation and SGP flexibility could advance reforms:
  - Without treaty changes the EU has limited legislative jurisdiction and low appetite for additional EU legislation.
  - Cautious use of SGP flexibility is needed to avoid undermining framework credibility and debt sustainability, given uncertainty about the impact of structural measures and country commitment.
- Authorities saw merit in focusing SGP reform on a debt anchor and an expenditure growth rule; more prominence could be given to the expenditure benchmark and debt criterion within the current fiscal framework.
- Some support for a technical EU-level fiscal council to underpin economic judgment on SGP maneuvering and dispel perceptions of politicized enforcement.

### Staff appraisal connections to benchmarking and governance (paragraphs 66–69 and related)
- Structural reforms are urgently needed to raise potential growth; national priorities include labor market reforms to reduce duality and increase employment opportunities, and product and service sector reforms to improve the business climate.
- Regional priorities include faster implementation of the Services Directive, improvements to insolvency regimes, and deeper single market integration in capital, transport, energy, and the digital economy.
- A capital markets union should focus on increasing transparency, improving market infrastructure and regulations, and promoting high quality securitization, especially for SMEs.
- A more effective governance framework would help advance structural reforms:
  - Using outcome-based structural reform benchmarks would improve transparency and accountability.
  - Selective use of EU legislation would help achieve progress in critical areas.
  - Better use of SGP flexibility for countries undertaking structural reforms would provide incentives for action.
  - An independent structural council at the EU level would enhance ex post monitoring.
  - National-level productivity councils could enhance ownership and innovation in reform program design.
- Fiscal framework recommendations tied to governance improvements:
  - Simplify and strengthen by focusing on two key pillars: a single fiscal anchor (public debt-to-GDP) and a single operational target (an expenditure growth rule, possibly with a debt correction mechanism).
  - Improve enforcement, monitoring, and coordination through better interaction between national fiscal councils and the EC, and possibly an EU-level independent fiscal council to assess SGP application.

*Source: Box 4, “Outcome-Based” Structural Reform Benchmarking (from the provided IMF content).*

### 2.2 percent of GDP in 2013. The cyclically-adjusted current account in 2014 is estimated to be a surplus of about 1.9 pe

### _cr15204 - 2.2 percent of GDP in 2013. The cyclically-adjusted current account in 2014 is estimated to be a surplus of about 1.9 pe

### Current account: levels, drivers, and assessment
- The cyclically-adjusted current account in 2014 is estimated to be a surplus of about 1.9 percent of GDP.
- The CA was 2.2 percent of GDP in 2013.
- Staff assesses that the euro area 2014 current account is broadly in line with the level suggested by medium-term fundamentals and desired policies (as in the EBA estimated norm), with a CA gap ranging from -1 to 1 percent of GDP.
- The CA norm of 2.0 percent of GDP reflects primarily the adverse demographics and weak medium-term growth prospects in the euro area.
- The CA is expected to strengthen further in 2015 by nearly one percent of GDP, reflecting:
  - an improvement in the net oil balance by about 0.7 percent of GDP,
  - some competitiveness gains,
  - continued weak domestic demand.
- External imbalances at the national level remain and are expected to persist.
- Improvements in the current accounts of debtor countries have been driven mainly by import compression, reflecting sluggish domestic demand, while surpluses in large creditor countries continue to increase.

### Real exchange rate (REER): background and assessment
- Background:
  - The CPI-based real effective exchange rate was essentially unchanged from 2013 to 2014.
  - The CPI-based REER fell by 10 percent as of May 2015, compared with its average level in 2014, reflecting both a nominal depreciation and slowing inflation in the euro area relative to its trading partners.
  - The nominal depreciation in 2015 is expected to persist, not least due to the divergent economic and monetary policy outlook among the major advanced economies.
- Assessment:
  - Staff assesses the euro area real exchange rate in 2014 (year average) to be consistent with medium-term fundamentals, with a REER gap of between -5 to 5 percent.
  - The REER depreciation in 2015 is also consistent with the near-term cyclical outlook and the need for continued monetary accommodation.
  - Important differences remain at the national level and are expected to persist.

### Capital and financial accounts: flows and policy measures
- Background:
  - The slight rise of the CA surplus in 2014 was mirrored by financial outflows on a net basis.
  - The financial account deficit was predominantly driven by bank-related and portfolio debt outflows, which were partially offset by increases in portfolio equity inflows.
- Assessment:
  - The trend of financial flows has closely followed developments in the current account and was supported by easing financial conditions in the euro area.
  - The return of capital flows would depend crucially on:
    - growth prospects of the region,
    - external conditions,
    - institutional reform efforts including the long-term vision to complete the architecture of the EMU.

### FX intervention and reserves level
- Background:
  - The euro has the status of a global reserve currency.
- Assessment:
  - Reserves held by euro area economies are typically low relative to standard metrics, but the currency is free floating.

### Technical notes and data vintage
- The IMF EBA analysis for the euro area covers 11 euro area members: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Portugal, and Spain.
- The assessments of CA and REER gaps for the euro area are derived from GDP-weighted averages of the assessments of the individual countries listed above, as well as from estimates for the euro area as a whole.
- When applying GDP-weighted aggregation for the euro area, the CA is corrected for reporting discrepancies in intra-area transactions, as the CA of the entire euro area is about ½ percent of GDP less than the sum of the individual 11 countries' CA balances (for which no such correction is available).
- Data vintage as of June 2, 2015.
- Revision since then indicates that the current account balance in 2014 is 2.1 percent of GDP in the euro area.

### Structural reform plans and progress — selected country highlights (from Table 4)
- France
  - Reform priorities:
    - Reform government spending to reach medium term fiscal objective.
    - Improve functioning of labor markets to re-absorb the unemployed, with a focus on the young and low-skilled.
    - Increase competition in service sectors with high economic impact.
    - Pursue a business-friendly environment for enterprises.
  - Recent progress:
    - 2014 pension reform (higher rates and longer contribution period for full pension).
    - Tightened budgetary target for health spending (ONDAM).
    - Targeted expenditure reviews.
    - Cut in employer’s social security contribution (Responsibility Pact).
    - Tax credit (CICE) on firms’ payroll on wages below 2.5*minimum wage.
    - Flexibility on hours and pay for firms in difficulties (Accords de maintien de l’emploi - AMEs).
    - Subsidized jobs for the young and low-skilled.
    - Portability of professional training rights; reduced judicial uncertainty (Macron law); liberalizations and Business Simplification Council.
  - Staff recommendations:
    - Institutionalize broad spending reviews to improve efficiency at all levels of government.
    - Reverse the growth in public employment at all levels of government.
    - Improve targeting of social benefits, including for unemployment, housing, and families.
    - Raise effective retirement age, make complementary pension pillar financially sustainable, and streamline special pension regimes.
    - Tighten caps on local taxes and borrowing, and eliminate “universal competency” clause.
    - Reform the minimum wage formula.
    - Reform unemployment benefits and strengthen job search framework.
    - Expand flexibility for social partners to agree on hours and pay at the enterprise level.
    - Improve targeting of professional education and training.
    - Strengthen the Competition Authority; allow SMEs to launch class actions in anti-trust cases.
    - Further reduce disincentives for SMEs to grow above certain employee thresholds.
    - Liberalize regulated professions not covered by the Macron law.
    - Enhance the effectiveness of the Business Simplification process.
    - Alleviate constraints on the supply of affordable housing and improve targeting of benefits.
    - Reduce regulated savings rates and review tax incentives for savings and insurance products.

- Germany
  - Reform priorities:
    - Increase labor force participation and facilitate immigration of qualified workers.
    - Increase productivity and competition, in particular in the services sector.
    - Clarify future energy policy with respect to pricing and infrastructure.
  - Recent progress:
    - Progress in extending child care provision.
    - Contribution rate for statutory pension insurance reduced and personal basic tax-free allowance increased in 2013.
    - Law to facilitate recognition of qualifications obtained abroad (2012). EU blue card facilitates skilled immigration.
    - Additional allocation to research and development in 2012–2014 budgets.
  - Staff recommendations:
    - Lower the tax wedge, in particular for the low-skilled and women.
    - Improve the provision of child care.
    - Further deregulate professional services.
    - Strengthen regulator’s powers to stop discrimination against incumbent operators’ competitors in railways and postal services.

- Greece
  - Reform priorities:
    - Improve labor market flexibility.
    - Foster competition in service and product markets.
    - Improve the business environment.
  - Recent progress:
    - Progress in all reform priorities is lagging.
    - The new government would like to reverse recent labor market reforms, including increasing the minimum wage back to the 2012 level, abolishing the subminimum wage and firm-level bargaining, and reinstating the favorability clause and extension of collective agreements.
    - The new government has committed to implementing only a handful of OECD recommendations to enhance competition in key sectors.
    - Authorities appear ready to proceed with limited liberalization of a few restricted professions, reduction of administrative burdens, and simplification of the licensing system on a restricted basis.
  - Staff recommendations:
    - No backtracking on any of the recent labor market reforms, including the minimum wage which still today on a GDP per capita basis is at the top end of the EU countries.
    - Keep the subminimum wage as youth unemployment at 26 percent is the highest in the EU.
    - Adopt legislative changes to align framework on collective dismissals and industrial actions in line with EU best practices.
    - Continue opening up regulated professions; implement pending OECD recommendations to reduce barriers to competition and expand work in additional sectors.
    - Continue overhauling the licensing system in line with international best practice while reducing the costs of establishing new businesses under the existing system.
    - Simplify customs procedures in line with EU practices, including electronic submission system for trade declarations and electronic payment.

- Portugal
  - Reform priorities:
    - Alleviate impediments to external competitiveness and potential growth.
    - Continue to improve the functioning of labor and product markets.
  - Recent progress:
    - Planning unit of Ministry of Finance given a formal mandate to monitor, evaluate, and coordinate structural reforms.
    - Proposed one-time levy on GALP to reduce gas prices by 3 to 5 percent for end users for the next three years, if effective.
    - Renegotiation of one port concession contract completed, with another four expected to follow soon.
    - New bylaws for 18 services and regulated professions approved by the Council of Ministers and under review in Parliament.
  - Staff recommendations:
    - Revisit reforms that have not yielded hoped-for results; fully implement already initiated reforms; address remaining bottlenecks through fresh reforms.
    - Upgrade quality of public services and policies, including raising effectiveness of public administration at central and local levels, reviewing functioning of the courts, and increasing payment discipline of public sector entities.
    - Continue measures to reduce cost of energy, use of transport infrastructure, and costs of professional and other services.
    - Strengthen market integration at the European level.
    - Promote managerial skills; more inclusive labor support system; avoid excessive increase of the minimum wage and find alternative policy tools to fight poverty.

- Spain
  - Reform priorities:
    - Address labor market duality and reduce high structural unemployment (especially among the youth and unskilled).
    - Boost productivity and competitiveness, particularly for small firms.
    - Improve access to financing for SMEs.
  - Recent progress:
    - The 2012 labor reform reduced severance payments and eased the use of fair dismissals; facilitated firm-level agreements.
    - Introduction of special contract for small firms that incentivizes hiring of permanent workers, particularly unemployed youth.
    - Social security contribution’s flat rate for permanent hires replaced by exemption of first 500 euros of SS contribution.
    - New active labor market policies (ALMP) aiming at improving skills of the long-term unemployed and low-skill youth.
    - Approved Market Unity Law (2013).
    - Insolvency regime: introduction of a “fresh start” for individuals and entrepreneurs; amendments to out-of-court restructuring mechanism for SMEs; restructuring and liquidation procedures.
  - Staff recommendations:
    - Build on the 2012 labor reform to address duality, including moving to a system of seniority-based dismissal cost for all workers.
    - Ensure conditions for continued wage moderation and wage growth differentiation across firms and sectors.
    - Monitor, evaluate, and strengthen ALMPs and training.
    - Reduce obstacles to firm growth by addressing excessive regulatory burden; swiftly implement the Market Unity Law; eliminate tax and size-related rules and regulations that create disincentives for firms to grow; liberalize professional services.
    - Continue to support internationalization of SMEs, e.g., by helping reduce high fixed costs of exporting.
    - Facilitate private sector deleveraging through legal reform: ensure effective design and implementation of the “fresh start;” facilitate in-court and out-of-court agreements to rehabilitate viable firms; harmonize all processes in light of recent changes.

- Italy
  - Reform priorities:
    - Raise public sector efficiency.
    - Improve the efficiency of civil justice.
    - Improve flexibility of the labor market.
    - Increase competition in product markets and services.
  - Recent progress:
    - Draft enabling law on public administration reform outlines ideas to reform recruitment and managerial compensation, reorganize public administration, digitize procedures, and streamline legislation governing SOEs.
    - New mandatory mediation scheme and measures to deal with backlog of pending cases and speed up case processing (2013).
    - Judicial reform measures to reduce backlog and speed up processing.
    - New law on civil liability of judges (2015); procedural reforms; extension of competence of specialized commercial chambers (2015).
    - The Jobs Act (Dec 2014) introduces a new labor contract with gradually increasing protection, lowers dismissal costs, and reduces the scope for reinstatement; expands social safety net and plans to strengthen active labor market policies.
    - Social partners agreed upon a Consolidated Act on Representation in 2014. Firm-level bargaining remains relatively unused.
    - Draft Annual Competition Law (Feb 2015) proposes measures to address existing regulatory barriers in a wide range of sectors.
  - Staff recommendations:
    - Adopt and implement the planned public administration reform, including reforms to provision of local public services; tendering procedures; and human resources management in the public administration to unlock productivity.
    - Further measures to improve efficiency of civil justice: rationalize types of cases that reach the Supreme Court; allow further specialization of courts; develop court performance indicators; use ad hoc measures to reduce backlog.
    - Legislate and implement concrete measures to redesign wage-supplementation scheme to turn it into universal support system conditional on job search and training, and strengthen active labor market policies as envisioned in the Jobs Act.
    - Further decentralize wage setting by allowing greater flexibility in national contracts and tackle constraints to second-stage wage bargaining.
    - Swift approval and implementation of the Annual Law on Competition and addressing existing regulatory barriers in key sectors—such as retail and transport—would support growth.
    - Full implementation of already legislated reforms by all levels of government is needed to improve business environment.

### Appendix 1 — Progress against IMF recommendations (2014 Article IV)
- Monetary Policy
  - 2014 Article IV advice:
    - If low inflation and fragmentation are not reversed, expand the ECB’s balance sheet substantially.
  - Actions since 2014 Article IV:
    - In addition to private asset purchases (since 2014Q4), sovereign QE was announced in January 2015 (and started in March 2015), involving public sector security purchases until at least September 2016.
  - Next steps:
    - Stay the course and if inflation fails to pick up after a reasonable period, stand ready to extend the program.
    - Expand flexibility in asset purchases and develop a (proactive) common securities lending framework within the Eurosystem to expand and facilitate market access to NCBs’ sovereign bond holdings.

- Fiscal Policy
  - 2014 Article IV advice:
    - Negative growth surprises should not trigger additional consolidation efforts.
    - Over the medium term, simplify and strengthen the fiscal governance framework.
  - Actions since 2014 Article IV:
    - Fiscal consolidation slowed in 2014 and the fiscal stance is projected to be broadly neutral in the coming years.
    - Discussions on fiscal governance are ongoing.
  - Next steps:
    - Use fiscal space and flexibility within the SGP to support investment and structural reforms.
    - Focus the fiscal framework on a single fiscal anchor (public debt-to-GDP) and a single operational target (an expenditure growth rule, possibly with a debt correction mechanism) linked to the anchor.

- Financial Policies
  - 2014 Article IV advice:
    - Complete AQR, reduce corporate debt overhang.
    - Complete the banking union and ensure operational readiness of SSM as integrated supervisor.
  - Actions since 2014 Article IV:
    - Under the Comprehensive Assessment (CA), banks have boosted their capital positions with only a few institutions showing a capital shortfall.
    - There has been progress in reducing corporate leverage in some countries.
    - The EC issued a Green Paper on Building a Capital Markets Union, stressing need for common standards for loan reporting requirements, greater integration of tax regimes, and harmonized debt enforcement and insolvency regimes.
  - Next steps:
    - Develop a multi-faceted strategy for NPL resolution, combining stricter supervision, structural reforms to enforcement and insolvency regimes, and measures to develop a market for distressed debt.
    - Harmonize capital requirements, including for deferred tax assets.
    - Establish a common fiscal backstop to effectively sever sovereign-bank links.
    - Ratify SRF agreement and accelerate SRF funding plans. Relax preconditions for using ESM direct recap and consider increasing the SRF.
    - Integrate capital markets and broaden funding sources for SMEs.
    - Support development of securitization markets.
    - Remove national differences in capital market infrastructure regulations.
    - Promote SME securitization.

- Structural Policies
  - 2014 Article IV advice:
    - Develop a comprehensive strategy to tackle youth unemployment.
    - Higher infrastructure investment in the creditor countries to reduce excessive surpluses.
    - Progress with reforms to product and labor markets.
    - Implement the Services Directive.
    - Make progress with free trade agreements.
    - More closely integrate energy platforms and policies.
  - Actions since 2014 Article IV:
    - Pan-European initiatives (e.g., Youth Guarantee, and Youth Employment Initiative) ongoing.
    - A centralized investment initiative (European Fund for Strategic Investment (EFSI)) was launched on July 4 and first transactions are expected in the second half of 2015.
    - Ongoing progress with reforms to product and labor markets (see Table 4 for country-specific progress).
    - Review of implementation of the Services Directive to be completed by end-2015.
    - The negotiations for Transatlantic Trade and Investment Partnership are ongoing. Free trade agreement with Canada completed.
    - EC announced proposal for an energy union; first legislative proposals are expected in late 2015 or early 2016.
  - Next steps:
    - See Table 4 for country-specific recommendations.
    - Implement swiftly the EFSI; particular attention should be paid to project selection to support new investment and to removing regulatory barriers.
    - Faster implementation of the Services Directive to promote cross border competition in services.
    - Progress on TTIP to support greater integration.
    - Progress on energy market union, including through benchmarking of reforms.

*Source: IMF country teams; data vintage as of June 2, 2015.*

### Appendix 2. Statistical Issues

### Appendix 2. Statistical Issues

### Overview
- European statistics are developed, produced, and disseminated within their respective spheres of competence by the European Statistical System (ESS) and the European System of Central Banks (ESCB).
- The ESS is composed of Eurostat and the national statistical institutes (NSIs); the ESCB is composed of the ECB and the national central banks (NCBs).
- The two systems operate under separate legal frameworks and cooperate closely when designing their respective statistical programs.
- The European statistics produced by the two statistical systems are of sufficient coverage, quality, and timeliness for effective macroeconomic surveillance.
- This appendix updates developments in statistical issues since the previous Article IV consultation with the euro area member states.

### Transition to new international statistical standards
- The transition to the new standards is largely complete.
- All member states now compile national accounts according to the new European System of National and Regional Accounts (ESA 2010).
- Many member states implemented benchmark revisions and other statistical improvements, including to data sources and compilation methods, to improve consistency and completeness.
- Most countries requested derogations in some areas up to 2020.
- The transition to the Sixth Edition of the IMF’s Balance of Payments and International Investment Position Manual (BPM6) is complete.
- The ECB’s new data reporting requirements on external statistics under BPM6 are more detailed, particularly regarding instrument breakdown within the various functional categories, and have full stock-flow reconciliation.
- Dissemination of BPM6-based data will be completed in 2015 when quality is sufficiently enhanced and large asymmetries coming from some euro area countries are addressed to reduce “errors and omissions”.
- Eurostat and the ECB are working on extending the availability of historical series and resolving outstanding issues.
- The methodology of monetary and financial statistics (e.g., interest rates, investment funds, financial vehicle corporations, securities issues) has been adapted; new statistics will become available in the second half of 2015.

### Initiatives to improve quality and timeliness
- Flash quarterly GDP estimates at T+30 days:
  - A Task Force established by the National Accounts Working Group assessed the feasibility of producing a flash estimate of euro area and European Union quarterly GDP at T+30 days.
  - Internal estimates of quarterly GDP have been produced at T+30 days and test calculations showed limited deviations from those produced at T+45 days.
  - Faster flash quarterly GDP estimates could be published next year if a majority of Member States supports them in a decision foreseen towards the end of this year.
- European level supply and use tables:
  - The FIGARO project, foreseen by Eurostat in cooperation with the Joint Research Centre of the European Commission, aims to establish an annual production of EU multi-country input-output tables and a five-yearly production of EU multi-country supply, use and input-output tables.
  - The output will support studies on competitiveness, growth, productivity, employment and international trade, and assessment of the position of the European Union and the euro area in the world.
- Harmonization of trade data:
  - Ongoing study of discrepancies between national accounts, balance of payments statistics, and international trade in goods and services statistics.
  - Largest gaps observed in imports and exports of goods reported in international trade statistics compared with national accounts and balance of payments.
  - Eurostat and the ECB are working on resolving discrepancies (e.g., to include illegal activities in the balance of payments data).

### Government Finance Statistics (GFS)
- Significant progress has been made to enhance economic and fiscal governance.
- Annual and quarterly ESA 2010-based GFS time series are available for all countries.
- Revisions to government deficit and debt levels due to ESA 2010 introduction occurred in October 2014, largely due to reclassification of units in the general government sector.
- Progress in national publication of monthly fiscal data based on public accounts, as required by the Enhanced Economic Governance Package (the “Six Pack”).
- In February 2015, and in the context of the “Six Pack”, Eurostat published for the first time data on contingent liabilities and non-performing loans of the government.
  - Contingent liabilities included government guarantees, liabilities related to public-private partnerships recorded off-balance sheet of government, and liabilities of government controlled entities classified outside general government (public corporations).
- Work is underway to encourage member states to improve comparability of data across countries.
- Technical work is ongoing to harmonize and modernize public sector accounting standards by moving to accruals based accounting in the context of the EPSAS (European Public Sector Accounting Standards) project.

### Effect of the European Fund for Strategic Investments (EFSI)
- The effect of EFSI on GFS remains uncertain.
- Eurostat is awaiting details on operational arrangements and the pipeline of transactions, in particular whether additional contributions will be made to EFSI by individual member states.
- It is possible that EFSI transactions will be added to government deficits, although this impact will be excluded by the European Commission for the purposes of the Excessive Deficit Procedure, in line with their communication on flexibility in the beginning of 2015.

### Statistics for the Macroeconomic Imbalances Procedure (MIP)
- Ongoing efforts aim to enhance MIP-relevant statistics.
- The ESS and the ESCB cooperate closely to assure the quality of MIP-relevant statistics.
- Main challenge: availability of historical time series of necessary length based on the new statistical standards; addressed in some cases by statistical estimation methods.
- Eurostat, in cooperation with the ECB, is developing a quality monitoring mechanism for data required for the MIP.
- A report on the quality of data is due to be published in the second half of 2015.

### ECB projects using new granular databases
- Money Market Statistical Reporting (MMSR):
  - An ECB Regulation (ECB/2014/48) adopted in November 2014 requires credit institutions to report daily their individual transactions relating to various segments of the money market as from April 2016 with full reporting commencing in July 2016.
  - Transaction-by-transaction data collection will comprise:
    - (i) daily unsecured borrowing transactions with maturity up to and including one year as well as interbank lending;
    - (ii) daily secured lending and borrowing transactions data; and
    - (iii) daily Foreign Exchange Swaps (FX Swaps) transactions and Overnight Index Swaps transactions denominated in euro (volume and rates).
  - Reporting Instructions are fully compliant with the ISO 20022 standard.
  - Some aggregated indicators based on the different markets will be released at a later stage to the general public.
- Securities holdings statistics:
  - Securities holdings statistics are being collected since end [content truncated in source].

*Prepared jointly by the European (EUR) and Statistics (STA) Departments of the IMF in consultation with Eurostat and the ECB. Florina Tanase acted as the STA coordinator.*

### 2013. The data contain quarterly security-by-security information on holdings of

### _cr15204 - 2013. The data contain quarterly security-by-security information on holdings of

### Data initiatives and enhancements
- Security-by-security holdings dataset:
  - Quarterly security-by-security information on holdings of individual securities by institutional sectors.
  - Collected after 70 days from euro area (and some other EU) national central banks and enriched with reference issuer and securities information by the Centralized Securities Database (CSDB).
  - Second module: security-by-security holdings by some individual euro area banking groups identified as important for stability and functioning of the financial system.
  - From 2016 the timeliness of the data collection will be enhanced to 55 days.
  - Granularity allows monitoring holdings of government debt with residual or original breakdown and on an individual bond level (e.g., recently issued bonds).
- Insurance corporations’ statistics:
  - ECB Regulation (ECB/2014/50) adopted in November 2014 requires quarterly balance sheets from May 2016, referring to data as at 2016Q1.
  - Granularity and expected quality comparable to balance sheet statistics of MFIs and investment funds.
  - Annual data on premiums, claims and commissions will be reported.
  - National central banks may use harmonized European supervisory reports (“Solvency II”) to compile statistics to limit reporting burden.
  - New statistics to be released for the first time towards the end of 2016; current non-harmonized ECB insurance corporations’ statistics will continue until reference period 2016Q2.
- Harmonized granular credit data:
  - Aim: long term framework for harmonized granular credit and credit risk data to support ECB/ESCB tasks (monetary policy analysis and operations, risk management, financial stability surveillance, macro-prudential policy).
  - Data provided by Central Credit Registers maintained by NCBs or similar granular statistical databases.
  - First reporting foreseen in early 2018 focusing on credit granted to non-financial and financial corporations, and general government.

### Supervisory statistics and data governance
- ECB supervisory statistics framework:
  - In 2014 ECB established a Supervisory Statistics Division within the Directorate General Statistics to manage data from supervised groups and individual institutions including coordination, receipt, quality management and reconciliation.
  - Entry into force of EBA’s Implementing Technical Standards (ITS) on supervisory reporting increased the amount of comparable information.
  - Framework now includes additional data on forbearance and non-performing loans (with uniform definitions), asset encumbrance, liquidity and leverage.
  - ECB published a decision to remove identified supervisory data gaps, mainly related to financial information under national accounting rules, rolling out from end-2015.
  - Data collection follows a “sequential approach”: banks → national supervisors → ECB → selected data disseminated to stakeholders.

### SME access to finance and surveys
- Survey enhancements:
  - Survey on SME Access to Finance reviewed; most recent survey included ad hoc questions on collateral requirements.
  - Regular questionnaire enriched with questions on export intensity, interest rates and sources of financing such as leasing and non-bank loans.
  - Sample size increased; over 11,000 enterprises interviewed in the euro area in the most recent survey round.
  - Larger EU-wide annual survey (since 2013) conducted in cooperation with the European Commission; next large survey conducted between September and October 2015 with results published on 1st December 2015.

### Data standards and SDR interest rate change
- Special Data Dissemination Standard plus:
  - ECB supported launch in November 2014 of the Special Data Dissemination Standard plus, the third and highest tier of the IMF’s Data Standards Initiatives.
  - Seven of the eight countries in the first cluster of adherents were EU Member States.
- SDR euro component interest rate change:
  - IMF Executive Board decided on December 22nd 2014 to change the interest rate for the euro component of the SDR interest basket.
  - New rate: the three-month spot rate derived from a yield curve based on euro area central government bonds with a rating of AA and above, published daily by the ECB.
  - Replaced the three-month Eurepo rate following the discontinuation of the Eurepo rate as of 31 December 2014.

### Statement by the Staff Representative — July 24, 2015 (Greece and market developments)
- Recent developments:
  - Greek parliament passed reforms as basis for starting negotiations on a new ESM program; several national parliaments endorsed these reforms.
  - With approval of bridge financing by the European Council, Greece met a July repayment to the ECB and cleared arrears to the Fund.
  - ECB increased its cap on emergency liquidity assistance (ELA) to Greek banks.
- Market outcomes:
  - Asset prices broadly returned to levels prior to recent turbulence; spreads on 10-year European sovereign bonds relative to the German Bund have declined; European equities—led by bank stocks—have gained.
  - 10-year German Bund yield fell to under 0.8 percent.
  - The euro is trading more than 3 percent lower relative to the U.S. dollar.
- Policy implications and risk management:
  - New policy instruments (e.g., QE) and stronger banking union have helped limit contagion but further episodes of uncertainty and volatility cannot be ruled out.
  - Policymakers should be ready to deploy and adapt the full arsenal of available instruments to manage spillovers.
  - To fully sever bank-sovereign links would require: a common deposit insurance scheme with a fiscal backstop, a larger and fully funded Single Resolution Fund, and easier access to direct bank recapitalization from the ESM.
  - Such risk-sharing should be supported by a stronger fiscal and structural governance framework.

### Authorities’ assessment of economic outlook, inflation and risks
- Growth and outlook:
  - Real GDP increased by 0.4 percent (quarter-on-quarter) in the first quarter, following an expansion of the same size in Q4 2014 — the highest 6-month growth rate since mid-2011.
  - Commission services' Spring 2015 forecast: real GDP to grow by 1.5 percent in 2015 and by 1.9 percent in 2016.
  - Staff forecast slightly less optimistic for 2016 due to a more pessimistic view on the rebound in investment.
  - Tailwinds supporting recovery include low oil prices, lower external value of the euro, and increased policy support including ECB non-standard measures.
  - Risks restraining strength in GDP growth: high unemployment, ongoing deleveraging in some countries, geopolitical tensions, weaker global trade, possible rebound in oil prices.
- Inflation:
  - After weakening and dragging inflation below zero, HICP inflation moved up in Q2 2015.
  - Commission services' Spring 2015 forecast: inflation at 0.1 percent in 2015 and 1.5 percent in 2016 as oil price effects fade and slack diminishes.
  - Staff expects a more moderate increase reflecting slower closing of the output gap.
  - Authorities and staff view deflation risks as declined; risks to inflation outlook are now balanced.
- Risks:
  - Staff assessment: risks to growth outlook more balanced than in recent years but refrains from assessing overall balance.
  - Authorities regard overall risks as broadly balanced by their forecast release.

### Policy recommendations and positions
- Monetary policy:
  - ECB’s expanded asset purchase programme: combined monthly purchases amounting to €60 billion on average, intended to run until end-September 2016, and in any case until the ECB’s Governing Council sees a sustained adjustment in the path of inflation consistent with its aim of achieving inflation rates below, but close to, 2 percent over the medium term.
  - ECB will use all instruments within its mandate if warranted to address unwarranted tightening or material changes in the outlook for price stability.
  - Other policy areas’ contribution is decisive to reap full benefits of monetary measures.
- Financial stability:
  - Europe’s financial markets and institutions have overall further stabilized; revised financial regulation and start of SSM operations were important contributors.
  - Main risks: abrupt reversal of global risk premia, weak profitability prospects for banks and insurers, high leverage in some financial institutions and clients, and potential risks from non-bank financial institutions.
- Fiscal policy:
  - Current fiscal stance for the euro area broadly appropriate; fiscal policies should reflect member-state conditions and sustainability risks while ensuring coordination.
  - Key challenge: reduce government debt by pursuing fiscal responsibility.
  - Some Member States need further fiscal adjustment; others have room to encourage domestic demand, especially investment.
  - Emphasis on prioritising investment, raising quality of public expenditure, improving tax efficiency and reducing tax wedge on labour.
  - Stability and Growth Pact flexibility can facilitate structural reforms and investment while following rules; Commission Communication (January 2015) clarifies use of flexibility.
  - On windfalls from lower interest payments: high-debt countries should use windfalls to consolidate; low-debt countries at or above MTOs could use windfalls to support structural reforms and increase public investment.
- Investment Plan for Europe and EFSI:
  - Authorities welcome staff’s positive assessment; careful project selection and swift implementation are key.
  - Projects selected by independent experts on merit; governance structure and list of strategic investment areas intended to balance market-based initiative and rationale for public intervention.
  - Several Member States have committed significant sums to finance EFSI-supported projects.
  - Third Pillar: actions at EU and country level to remove barriers to investment and reinforce Single Market; priorities include Capital Market Union, deeper Single Market for goods and services, Digital Single Market, Energy Union, and transport.
- Bank balance sheet repair:
  - Authorities stress efforts to strengthen banking sector, including Comprehensive Assessment prior to SSM entry into force.
  - Agree on need to continue repairing bank balance sheets; NPLs remain very high in some countries and have risen further in some cases.
  - Addressing high NPLs is necessary (though not sufficient) to support lending, growth and jobs.
  - Some Member States have reduced NPLs rapidly using Asset Management Companies.
  - Need to explore incentive frameworks for banks to address NPLs considering EU state aid and BRRD rules.
  - Legal, institutional and market framework (foreclosure/bankruptcy laws, judicial procedures, markets for distressed loans, tax rules, prudential supervision) should be revisited to support quicker balance sheet repair; progress underway in several Member States.
- Capital Market Union:
  - Action plan under preparation following Commission Green Paper; objective to set a single market for capital to improve cost efficiency, competition and diversification of funding.
  - Emphasis on SMEs and recalibrating regulatory framework to enhance investment and access to finance to improve market-based risk sharing.
- Structural reforms:
  - Targeted, country-specific reforms in labour and product markets needed to foster investment, boost employment and potential growth, support rebalancing and improve business environment.
  - Reforms should remove barriers to financing and project launch (inefficient taxation, low public administration transparency/efficiency, barriers to SME finance and long-term projects, infrastructure investment barriers).
  - Reinforcing Single Market and efforts for services, digital economy and energy will support reform momentum.
- Economic governance:
  - Need to improve and streamline surveillance system and complete euro area architecture.
  - Report on “Completing Europe’s Economic and Monetary Union” (June, Five Presidents) recommends accelerating Banking Union completion and reinforcing governance to enhance convergence, competitiveness and stability.
  - Outcome-based benchmarking for euro-area priorities in structural reforms could increase specificity, transparency and accountability but requires careful study due to measurability and timeliness challenges.

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

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