## _cr16219 - 1.1 percent next year. ## Source details **Canonical URL:** [_cr16219 - 1.1 percent next year.](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16219.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16219.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16219.pdf.json) --- ### Near-term outlook and risks - Staff projection headline: "1.1 percent next year." - Recent momentum and drivers: - 2015 growth picked up to 1.7 percent driven by domestic demand; Q1 GDP growth at 0.6 percent quarter-on-quarter. - Recovery drivers: still low oil prices, a neutral fiscal stance, and accommodative monetary policy supporting the recovery. - Inflation and inflation expectations: - Euro area headline inflation was -0.1 in May 2016; core inflation was 0.8 percent. - The 2-year/2-year inflation swap rate hovered around 0.9 percent. - Output gap and external position: - Output gap: estimated at around -2 percent of GDP in 2015. - Current account surplus rose to 3.2 percent of GDP in 2015 (also reported as strengthened to 2.7 percent of GDP in 2015 in alternative assessment). - Downside risks: - A further global slowdown could derail the domestic demand-led recovery. - Political risks: spillovers from the U.K. post-referendum situation, refugee surge, or heightened security concerns could increase uncertainty. - Banking and financial sector weaknesses in some countries. - Prolonged low growth and inflation increase euro area vulnerability to shocks. - Policy buffers described as low. ### Medium-term prospects and stagnation risks - Staff view: "Medium-term prospects are mediocre, with crisis legacies of high unemployment, elevated public and private debt, and deep-rooted structural weaknesses weighing on the outlook and productivity growth." - Projections and scenarios: - Growth five-years ahead is expected to be about 1.5 percent, with headline inflation reaching only 1.7 percent. - Potential growth over the next five years: 1.2 percent. - Unemployment declining but only reaches about 8.5 percent by 2021 (2001–2008 average). - Stagnation scenario: if a demand shock lowers investment growth by ¼ percentage points annually for five years and pushes up spreads, growth and inflation could fall to about one percent. - Stagnation scenario projection: 0.4 percent by 2021, with real imports contracting. - Under a comprehensive coordinated policy scenario (EUROMOD exercise), output would be 2.2 percent higher than baseline by 2021 and headline inflation would reach 2 percent by 2019 (baseline: 1.7 percent by 2021). ### External position and REER developments - REER and current account: - REER depreciated by some 8.5 percent in 2015; appreciated by some 2 percent so far in 2016 (alternative figures: CPI-based REER depreciated by 8.6 percent from 2014 to 2015; as of May 2016, REER appreciated by 1.9 percent relative to 2015 average). - Current account: rose to 3.2 percent of GDP in 2015 (alternative statement: strengthened to 2.7 percent of GDP in 2015 with two-thirds of improvement reflecting higher energy balance). - EBA model CA gap (2015): -0.3 percent of GDP (other EBA estimate reported -0.2 percent); staff assesses CA gap range for 2015 as -0.5 to 1.5 percent of GDP. - Cross-country REER gaps: - Germany: undervaluation of 10-20 percent. - Spain: overvaluation of 5–10 percent. - Policy implication: external creditors should strengthen domestic demand (reduce surpluses); external debtors should raise productivity and competitiveness. ### Refugee surge: magnitude, impacts, and risks - Magnitude: The EU registered about 1,260,000 new asylum seekers in 2015. - Short-run fiscal and GDP effects: - Fiscal outlays associated with refugees will raise EU GDP by some 0.1 percent by 2017. - Fund staff discussion note: for the EU as a whole, GDP could be between 0.2–0.25 percent higher by 2020, depending on speed of integration. - Downside risks from continued inflows: - Could strain accommodation and processing systems; deepen political divisions; prompt reestablishment of border controls. - Economic cost estimates of reestablishing Schengen border controls: - European Commission: direct costs estimated between €5 and €18 billion annually (0.03-0.12 percent of GDP). - France Stratégie: trade between Schengen countries could fall by 10-20 percent, lowering EU Schengen GDP by 0.9 percent by 2025. - Bertelsmann Foundation: 1–3 percentage points increase in import prices, reducing EU GDP by 0.4–1.2 percent by 2025. ### Corporate debt, investment, and firm-level effects - Investment trends: - NFC gross investment relative to GDP fell from about 24 percent of GDP in 2007 to about 21 in 2009. - Average euro area country saw investment drop almost six percentage points of GDP over 2007–2014. - Leverage and investment sensitivity: - Firms’ investment ratio is about 3 percentage points lower on average across firm sizes for a 10 percentage point rise in leverage. - Impact of leverage on investment is about 25 percent larger for SMEs than for large firms. - Post-crisis, investment ratio rises by about one percentage point for a 10 percentage point rise in sales growth (pre-crisis: over four percentage points). - Policy implication: reduce corporate indebtedness, facilitate restructuring of viable firms, and shut down unviable firms to boost investment and reallocate resources. ### Monetary policy: stance, transmission, and further easing options - Current stance: - Monetary policy is appropriately accommodative and open-ended; ECB’s March package: further cut of all policy rates, increase in monthly asset purchases to €80 billion, CSPP, and TLTRO II. - Transmission and effects: - Asset purchases compressed sovereign term premia (term spreads have fallen by 50 basis points) and supported portfolio rebalancing; euro depreciated by 6 percent in real effective terms since August 2014 speech. - Corporate issuance increased after CSPP announcement; bank lending rates declined and credit picked up modestly. - Limits and further easing: - Negative policy rates lower NIMs: combination of NIRP and expanded APP lowers NIMs of euro area banks in 2016 by 11 basis points on average (Annex I). - Aggregate lending would need to increase 2.3 percent annually (up from 1.8 percent at end-January) for banks to maintain current profitability over loan amortization period (Annex I). - Staff suggests further easing should come primarily from expanding asset purchases (staff analysis: an additional €2.4 trillion of assets after planned purchases through March 2017 would be available after applying limits and capital key; a one-year extension equivalent to about €960 billion). - Further deposit rate cuts face limits due to adverse effects on bank profitability; priority on credit easing and asset purchases. - Market functioning recommendation: - Develop a common securities lending framework for NCBs and encourage lending via multiple central counterparties to avoid collateral scarcity. ### Banking sector repair and completing the Banking Union - Key challenges: - Bank profitability remains low; high NPL ratios in Cyprus, Greece, Ireland, Italy, Portugal; overbanking and large bank assets relative to capital markets. - Stock of NPLs marginally declined to €900 billion as of end-June 2015 (down from €932 billion or 9.2 percent of GDP at end-2014). - Resolution strategy: - Accelerate NPL resolution via stricter supervision (conservative provisioning, capital surcharges, time limits on NPL disposals), set time-bound NPL disposal targets, harmonize insolvency and foreclosure frameworks, develop distressed debt markets, and use AMCs where appropriate. - Any state intervention in systemic cases should apply EU State Aid rules flexibly. - Banking union completion: - SRM in place and SRF financed after one year; missing final pillar: common deposit insurance (EDIS) — proposal linked to DGSD implementation and gradual coverage increase. - A common fiscal backstop (e.g., ESM credit line) is needed for EDIS and SRF during transition; ESM could engage in precautionary direct bank recapitalizations with appropriate conditionality. - Prudential and structural measures: - Consider more risk-sensitive prudential treatment of banks’ sovereign exposures consistent with global standards and phased-in. - Advance capital markets union to diversify financing and enhance private risk sharing. ### Fiscal policy: promoting investment, rebuilding buffers, and governance - Fiscal stance: - After years of consolidation, fiscal stance turned mildly expansionary in 2016; fiscal easing in 2016 coming mainly from Germany, and to a lesser extent Austria and Italy. - Beyond 2016, fiscal stance projected to turn slightly contractionary as refugee-related spending wanes. - Fiscal space and recommendations: - Fiscal space limited in many countries given debt sustainability, SGP targets, and national rules. - Countries with fiscal space should use it to promote investment and structural reforms; countries without fiscal space should stick to consolidation plans and rebuild buffers using interest savings. - All countries should pursue growth-friendly fiscal rebalancing: boost public investment, reduce high marginal tax rates on labor and capital, cut unproductive spending while broadening tax base. - In a severe euro area-wide downturn, invoke the escape clause to suspend temporarily the fiscal adjustment required under the SGP. - Regional measures: - Expand centrally-financed investment schemes (EFSI has approved over €100 billion in projects so far) and consider additional centralized investment schemes financed via expanded EU budget or new common fund for shared projects. - Access to central fiscal support could be conditional on implementing structural reforms and compliance with fiscal rules. - Fiscal framework reform: - Strengthen enforcement of SGP rules; adopt a simpler framework with a single fiscal anchor and single operational target. - Ensure the European Fiscal Board (EFB) is fully independent and linked to national fiscal councils. ### Structural reforms, governance, and outcome-based benchmarks - Staff priorities: - Prioritize structural reforms that can provide near-term demand support: reduce barriers to entry in retail and professional sectors, improve public administration, lower labor tax wedges, and reduce labor market duality. - Introduce outcome-based benchmarks to incentivize reforms and strengthen enforcement of the Macroeconomic Imbalance Procedure. - Six priority benchmark indicators (selected): - (i) OECD indices on regulatory barriers in professional services sectors; - (ii) the licenses needed to engage in retail trade; - (iii) employment protection in regular work contracts; - (iv) the labor tax wedge; - (v) the World Bank measure of the number of days to enforce a contract; - (vi) measures of public sector value added per employee. - Example: labor tax wedge - Reducing the labor tax wedge by 1 percentage point can raise output and employment by 0.8 and 1.2 percent respectively after 4 years. - Governance and enforcement: - Link CSRs to ambitious, concrete, measurable outcome-based benchmarks; use EU legislation where possible; strengthen enforcement including opening the EIP against repeat offenders. - Use ESI funds, SGP flexibility, and EU technical assistance to support reforms; consider independent national competitiveness boards. - Political-economy constraints: - Pace of benchmarking and enforcement is politically challenging; progress on some benchmarks is slow due to need for consensus and data limitations. ### Quantified policy-simulation findings (EUROMOD exercise) - Scenario assumptions: - Continued monetary accommodation by the ECB. - Use of existing fiscal space including flexibility under the SGP amounting to around 0.4 percent of euro area GDP over 2017–18. - Centrally-financed investment around 1 percent of GDP for 2017–21. - Reduced credit risk premia from bank balance sheet cleanup. - Implementation in 2018 of product and labor market reforms per G20’s 2014 Comprehensive Growth Strategy. - Main findings relative to April 2016 WEO: - Euro area growth 0.3 percentage point higher on average in 2017 and 2018, closing output gap by 2018 about two years earlier. - By 2021, output 2.2 percent higher than baseline. - Headline inflation 2 percent by 2019 versus baseline 1.7 percent by 2021. - Aggregate public debt 3 percent of GDP lower by 2021; larger declines in high debt countries (4 percent of GDP on average). - Euro area current account surplus declines to 2.2 percent of GDP by 2021; Germany’s surplus on average 0.3 percent of GDP lower each year. ### Key numeric highlights (preserved exactly) - Growth: 2015: 1.7 percent; growth projected at 1.7 percent this year and next (alternative staff update: 1.6 percent this year and 1.4 percent next year after UK referendum). - Staff headline: "1.1 percent next year." - REER: depreciated by some 8.5 percent in 2015; appreciated by some 2 percent so far in 2016 (alternative: CPI-based REER depreciated by 8.6 percent from 2014 to 2015; as of May 2016 appreciated by 1.9 percent). - Headline inflation: reaching 0.3 percent in 2016 (then anticipated to pick up gradually); euro area headline inflation was -0.1 in May 2016; core inflation 0.8 percent. - EU registered about 1,260,000 new asylum seekers in 2015. - Refugee-related GDP boost: some 0.1 percent by 2017; GDP could be between 0.2–0.25 percent higher by 2020 per Fund staff discussion note. - Estimated direct costs of reestablishing border controls: €5 and €18 billion annually (0.03-0.12 percent of GDP). - Trade reduction estimate: 10-20 percent; GDP reduction 0.9 percent by 2025 (France Stratégie). - Bertelsmann Foundation import price scenario: 1–3 percentage points increase in import prices, reducing GDP by 0.4–1.2 percent by 2025. - Growth five-years ahead expected about 1.5 percent; headline inflation 1.7 percent; potential growth 1.2 percent. - Unemployment reaches about 8.5 percent by 2021. - Stagnation scenario assumption: investment growth lowered by ¼ percentage points annually for five years; growth and inflation could fall to about one percent. - NFC gross investment: about 24 percent of GDP in 2007 to about 21 in 2009. - Average country investment drop: almost six percentage points of GDP over 2007–2014. - Firms’ investment ratio about 3 percentage points lower for a 10 percentage point rise in leverage. - Post-crisis investment response: investment ratio rises by about one percentage point for a 10 percentage point rise in sales growth (pre-crisis over four percentage points). - NPL stock: €900 billion as of end-June 2015 (down from €932 billion or 9.2 percent of GDP at end-2014). - NIRP and APP effect: lowers NIMs of euro area banks in 2016 by 11 basis points on average; aggregate lending would need to increase 2.3 percent annually (up from 1.8 percent at end-January) to maintain profitability. - Staff asset-purchase capacity estimate: an additional €2.4 trillion of assets after planned purchases through March 2017 would be available after applying limits and the ECB’s capital key; a one-year extension equivalent to about €960 billion. - EUROMOD coordinated investment: centrally-financed investment of around 1 percent of GDP for 2017–21. - Fiscal flexibility assumption in EUROMOD: around 0.4 percent of euro area GDP over 2017–18. *Source: EURO AREA POLICIES — STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION (IMF staff text from _cr16219).* ### 1.1 percent next year. ### _cr16219 - 1.1 percent next year. ### Near-term outlook and risks - Staff projection headline: "1.1 percent next year." - Recovery drivers: still low oil prices, a neutral fiscal stance, and accommodative monetary policy supporting the recovery. - Recent momentum: 2015 growth picked up to 1.7 percent driven by domestic demand; Q1 GDP growth at 0.6 percent quarter-on-quarter. - Inflation: euro area headline inflation was -0.1 in May 2016; core inflation was 0.8 percent. The 2-year/2-year inflation swap rate hovered around 0.9 percent. - Output gap: estimated at around -2 percent of GDP in 2015. - External position: current account surplus rose to 3.2 percent of GDP in 2015. - Downside risks (external and domestic): - A further global slowdown could spill over and derail the domestic demand-led recovery. - Political risks: spillovers from the U.K. post-referendum situation, the refugee surge, or a heightening of security concerns could increase uncertainty, hurting growth and hindering progress on policies and reforms. - Banking and financial sector weaknesses in some countries. - Prolonged low growth and inflation increase euro area vulnerability to shocks. - Policy buffers: described as low. ### Medium-term prospects - Staff view: "Medium-term prospects are mediocre, with crisis legacies of high unemployment, elevated public and private debt, and deep-rooted structural weaknesses weighing on the outlook and productivity growth." - Five-year projection: growth five-years ahead is expected to be about 1.5 percent, with headline inflation reaching only 1.7 percent. ### Executive Board assessment (summary of directors' views) - Overall: Recovery continues but inflation and inflation expectations remain stubbornly low; crisis legacies (high unemployment and debt) and structural weaknesses weigh on the medium-term outlook. Risks increasingly to the downside and policy buffers limited. - Political risk emphasis: heightened uncertainty related to the U.K. referendum outcome and its new economic relationship with the European Union; an intensification of the refugee surge could prompt additional border controls and hinder free movement within the single market. - Directors’ warnings: without decisive actions, the euro area will remain vulnerable to instability and repeated crises of confidence. ### Policy recommendations and priorities - Comprehensive and balanced policy package needed collectively to boost growth, rebuild buffers, and strengthen integration. - Structural reforms (priorities and governance): - Prioritize structural reforms that can provide near-term demand support: reduce barriers to entry in retail and professional sectors, improve public administration, lower labor tax wedges, and reduce labor market duality. - Introduce outcome-based benchmarks to incentivize reforms and strengthen enforcement of the Macroeconomic Imbalance Procedure. - Fiscal policy and investment: - Promote investment and improve fiscal governance. - Given limited national fiscal space, expand centralized investment schemes or funds for common projects. - Countries with fiscal space should use it to promote investment and structural reforms; countries without space should stick to consolidation plans and use interest savings to rebuild buffers. - Access to any new central fiscal support could be conditional on implementation of structural reforms and compliance with fiscal rules; strengthen and simplify the fiscal framework to encourage compliance. - Monetary policy: - Maintain monetary easing to boost inflation; the ECB’s monetary easing has improved financial conditions and expanded credit. - Negative interest rates have contributed to lower bank funding costs, higher asset values, and more bank lending. - Most Directors cautioned that further rate cuts may entail diminishing returns by squeezing banks’ net interest margins; a few Directors argued for a more holistic assessment including valuation gains and improved asset quality. - If the inflation outlook deteriorates, further easing—primarily through expanded asset purchases—would be warranted. - Banking union and financial sector repair: - Complete the banking union: common deposit insurance and a common fiscal backstop considered essential. - Urgent balance sheet repair: set targets for banks to reduce impaired assets; accelerate non-performing loan resolution. - Complementary measures: strengthen and harmonize insolvency and foreclosure frameworks; promote distressed debt markets; use asset management companies where appropriate; apply State aid rules flexibly in systemic cases. - Any changes to prudential treatment of banks’ sovereign assets should be consistent with global standards. - Advance capital markets union to diversify financing sources and enhance private risk sharing. ### Key messages and synthesis - "Euro area at a crossroads": growing political divisions and euroskepticism raise the risk that the usual approach of "muddling through" becomes untenable. - Necessary collective actions: complete the banking union, expand centralized sources of investment, prioritize structural reforms with stronger enforcement of fiscal and economic governance frameworks, and accelerate bank balance sheet cleanup. - Objective: boost growth, rebuild buffers, strengthen integration, and reduce vulnerability to future shocks. *Source: EURO AREA POLICIES — STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION (June 20, 2016).* ### 0.7 percentage points from 2014, led by the oil balance. Overall, the euro area’s external position in ### _cr16219 - 0.7 percentage points from 2014, led by the oil balance. Overall, the euro area’s external position in ### External position and REER developments - The euro area’s external position in 2015 remained broadly consistent with the level implied by medium-term fundamentals (Table 2). - In 2015, the real effective exchange rate (REER) depreciated by some 8.5 percent, reflecting the euro area’s weak cyclical position, low inflation, and accommodative monetary policy, ending broadly in line with the level consistent with medium-term fundamentals. - So far in 2016, the REER has appreciated by some 2 percent. - Progress in external rebalancing remains slow: - Current account improvement in 2015 was broad-based but driven by different national factors. - Debtor countries (e.g., Portugal and Spain) improved current accounts through competitiveness gains from price adjustments. - Some large creditor countries (e.g., Germany) have surpluses that moved further away from levels suggested by fundamentals due to weak investment and stronger fiscal positions. - Stock imbalances remain large and vary greatly across countries; countries with sizeable net foreign liabilities may be vulnerable to a sudden stop in capital flows. - Policy implication: Further adjustment is needed by external creditors to strengthen domestic demand (reducing surpluses) and by external debtors to raise productivity and competitiveness (improving current accounts). ### Near-term outlook and risks - Growth projections and inflation: - Growth is projected at 1.7 percent this year and next. - After reaching 0.3 percent in 2016, headline inflation is anticipated to pick up only gradually, reflecting the persistent output gap. - Fiscal and monetary context: - The ECB’s policies should support easier financial conditions and activity. - The fiscal stance is projected to turn mildly expansionary, mainly due to higher refugee-related spending in some countries and some relaxation of the fiscal stance elsewhere. - Downside risks (domestic and external): - External: a further global slowdown could reduce investment and employment, derailing the domestic demand-led recovery. - Domestic political risks: fallout from a “Leave” or marginal “Remain” vote in the U.K. referendum, insufficient progress on a common response to the refugee surge, and/or further terrorist incidents. - A “Yes” vote for Brexit could trigger volatile currency movements and financial contagion in the near term. - Combined with the refugee surge and security concerns, a “Leave” or unconvincing “Remain” outcome could fuel euroskeptic sentiment, deteriorating trust between member states, increasing financial fragmentation and uncertainty. - Domestic macroeconomic vulnerabilities: - Prolonged low growth and inflation leave the region more vulnerable— even a small shock could tip the economy into recession. - Other risks include banking and financial sector weaknesses in some countries. ### Refugee surge: economic impact and risks (Box 1) - Magnitude: - The EU registered about 1,260,000 new asylum seekers in 2015, more than double the 2014 number. - Short-run fiscal and GDP effects: - Fiscal outlays associated with providing for refugees will lead to a modest boost to GDP growth, raising EU GDP by some 0.1 percent by 2017, with more pronounced effects in destination countries such as Austria, Germany, and Sweden. - IMF Fund Staff Discussion Note: for the EU as a whole, GDP could be between 0.2–0.25 percent higher by 2020, depending on the speed of integration. - Downside risks from continued inflows: - Could further strain systems for accommodating and processing asylum seekers in EU entry and destination countries. - Lack of a comprehensive response could deepen political divisions and lead to reestablishment of more permanent border controls, with spillovers to countries outside the EU. - Economic cost estimates of reestablishing Schengen border controls: - Direct costs estimated by the European Commission between €5 and €18 billion annually (0.03-0.12 percent of GDP). - France Stratégie predicts border controls would reduce trade between Schengen countries by 10-20 percent, lowering the GDP of EU Schengen countries by 0.9 percent by 2025. - Bertelsmann Foundation study assumes a 1–3 percentage points increase in import prices, reducing GDP for the EU by 0.4–1.2 percent by 2025. ### Medium-term prospects and stagnation risks - Outlook and medium-term averages: - Growth five-years ahead is expected to be about 1.5 percent, with headline inflation reaching only 1.7 percent. - Average potential growth over the next five years has improved slightly but remains subdued at 1.2 percent. - Workforce aging is a drag through its impact on total factor productivity according to staff analysis. - Unemployment is declining but only by 2021 does it reach its 2001–2008 average of about 8.5 percent. - Debt and investment constraints: - Total debt (public and private) is above pre-crisis levels. - Business investment has started rising but lags the recovery, reflecting chronic weak demand, high corporate indebtedness, and weak growth prospects. - High levels of nonperforming loans (NPLs) continue to undermine bank profitability and constrain new lending in some countries. - Continued downward revisions to nominal GDP over the medium term have intensified debtors’ adjustment challenge. - Stagnation scenario: - If a demand shock lowers investment growth by ¼ percentage points annually for five years and pushes up spreads, growth and inflation could fall to about one percent. - Consequences: worsened public and private debt burdens and external imbalances; limited national fiscal space and lack of a euro area-wide countercyclical instrument would place the burden on the ECB to press further with unconventional policies. ### The drag from corporate debt and firm-level investment (Box 2) - Aggregate and firm-level investment trends: - Gross investment by non-financial corporations (NFCs) relative to GDP fell from about 24 percent of GDP in 2007 to a low of about 21 in 2009. - The average euro area country saw investment drop almost six percentage points of GDP over the period 2007–2014. - At the firm-level, the investment fall and slow recovery is most evident at small and medium enterprises (SMEs). - Leverage and investment sensitivity: - High corporate indebtedness may partly account for the weakness of firms’ investment. - Leverage for SMEs rose with the crisis, while remaining stable for large firms. After peaking in 2010, SME leverage has come down, but only very slowly and remains above its pre-crisis level. - Staff analysis suggests that firms’ investment ratio is about 3 percentage points lower on average across firm sizes for a 10 percentage point rise in leverage. - The estimated impact of leverage on investment is about 25 percent larger for SMEs than large firms. - The sensitivity of investment to sales growth has declined: post-crisis the investment ratio rises by about one percentage point for a 10 percentage point rise in sales growth, compared to a pre-crisis rise of over four percentage points. - Policy implications: - Measures to reduce corporate indebtedness could help boost firm investment and enhance transmission of monetary and fiscal policies to investment. - The shutdown of unviable firms and debt restructuring for viable but distressed firms (the flipside of some NPLs held by banks) could facilitate growth-friendly deleveraging and reallocation of resources to more productive firms. ### Key numeric highlights (preserved exactly from source) - REER depreciated by some 8.5 percent in 2015; appreciated by some 2 percent so far in 2016. - Growth projected at 1.7 percent this year and next. - Headline inflation reaching 0.3 percent in 2016 (then anticipated to pick up gradually). - EU registered about 1,260,000 new asylum seekers in 2015. - Refugee-related GDP boost: some 0.1 percent by 2017; GDP could be between 0.2–0.25 percent higher by 2020 per Fund staff discussion note. - Estimated direct costs of reestablishing border controls: €5 and €18 billion annually (0.03-0.12 percent of GDP). - Trade reduction estimate from France Stratégie: 10-20 percent; GDP reduction 0.9 percent by 2025. - Bertelsmann Foundation import price scenario: 1–3 percentage points increase in import prices, reducing GDP by 0.4–1.2 percent by 2025. - Growth five-years ahead expected about 1.5 percent; headline inflation 1.7 percent; potential growth 1.2 percent. - Unemployment reaches about 8.5 percent by 2021 (2001–2008 average). - Stagnation scenario assumption: investment growth lowered by ¼ percentage points annually for five years; growth and inflation could fall to about one percent. - NFC gross investment: about 24 percent of GDP in 2007 to about 21 in 2009. - Average country investment drop: almost six percentage points of GDP over 2007–2014. - Firms’ investment ratio about 3 percentage points lower for a 10 percentage point rise in leverage. - Post-crisis investment response: investment ratio rises by about one percentage point for a 10 percentage point rise in sales growth (pre-crisis over four percentage points). *Source: IMF staff (from _cr16219).* ### 0.4 percent by 2021, with real imports contracting ### _cr16219 - 0.4 percent by 2021, with real imports contracting ### Growth outlook and simulation findings - Stagnation scenario projects 0.4 percent by 2021, with real imports contracting. - Euro area baseline and stagnation scenarios referenced against the Apr 2016 WEO baseline in staff calculations (figures shown for GDP growth and inflation simulations). - Specific cross-border trade impacts in the stagnation scenario: - Other EU countries’ exports would fall by 1.4 percent in 2021. - Exports for the rest of the world would decline by 0.4 percent. - A separate projection shows 2.8 percent in 2021 (context indicates an alternative simulation outcome). - Stagnation in the euro area could lower confidence and raise global risk aversion. ### Authorities’ views and macro conditions - Near-term growth: Authorities were positive on near-term growth, expecting domestic demand—underpinned by low oil prices, a mildly expansionary fiscal stance, accommodative monetary policy, and employment gains—to continue driving growth and put it slightly above staff’s forecast by 2017. - Risks: Authorities agreed downside risks are dominated by geopolitical factors, including the refugee surge and skepticism about Europe highlighted by the U.K. referendum. - Inflation: Authorities (ECB) expect oil price developments and monetary policy actions announced in March to support a faster recovery in headline inflation than staff expected. Core inflation remains subdued. Labor market improvements are occurring, but compositional shifts toward low-paying service jobs and other changes are holding down aggregate wage growth. - Real exchange rate and current account: - ECB viewed the current account in 2015 as broadly in line with fundamentals and found the real effective exchange rate so far this year to be marginally stronger than implied by fundamentals. - The European Commission projects the real effective exchange rate as somewhat undervalued for 2016. - Both the ECB and EC stressed stronger investment by creditor countries as necessary to narrow persistent external imbalances within the euro area. - Medium-term outlook: Authorities concurred the medium-term outlook is lackluster, with potential growth only around 1 percent. Refugee inflows and higher participation will temporarily boost the labor contribution, but weak investment, aging, and limited total factor productivity improvements weigh on potential. - Governance concerns: The EC shares concerns about stagnation risks and the possibility of more fundamental threats to the monetary union if divergent diagnoses prevent steps toward further integration. ### Structural reform priorities and findings - Progress and gaps: - Progress on structural reforms has flagged; pace is too slow given large structural gaps in many countries. - Compliance with the 2015 Country Specific Recommendations (CSR) under the European Semester has worsened relative to 2013–14 CSRs. - Implementation of the Services Directive—especially in retail and professional service sectors—has been slow, particularly in larger economies. - Productivity: Sizeable cross-country differences in productivity persist, especially in services where productivity remains below pre-crisis levels and lags other advanced economies. - Without faster structural reform progress, potential growth in the euro area will remain low, limiting the ability of countries to rebuild buffers and address crisis legacies. - Reform types prioritized (drawn from national priorities and staff analysis): - Product market reforms: - Reduce entry barriers in the professional and retail sectors. - Improve the efficiency of public administration. - Strengthen insolvency regimes. - Complete single markets in services, energy, digital commerce, and transport. - Advance an ambitious Transatlantic Trade and Investment Partnership (TTIP) agreement to enhance productivity and competition. - Labor market reforms: - Lower unemployment and increase labor force participation among the young, elderly, women, and the long-term unemployed. - Shrink the labor tax wedge. - Expand cost-effective active labor market policies (ALMPs), noting these boost growth and employment even if budget neutral and have larger effects if accompanied by fiscal support. - Consider reducing excessive protections for regular workers and excessive unemployment benefits where appropriate, while taking care to mitigate downside risks during downturns. - Use credible commitments (for example, legal changes phased-in over time) to achieve medium-term benefits while mitigating short-term consequences. - Public administration reforms: Improve efficiency and bring spending forward to support demand when appropriate. - Evidence of reform payoffs: Structural reforms have already paid dividends in some places, such as Spain and Portugal, though large rigidities remain. ### Strengthening economic governance and enforcement - Need for stronger enforcement: - The economic governance framework needs significant strengthening to better incentivize structural reforms. - Stronger enforcement of the current framework—including opening the Excessive Imbalance Procedure (EIP) against repeat offenders—would increase compliance and build credibility. - Benchmarking and accountability: - The 2016 European Semester and Macroeconomic Imbalance Procedure (MIP) should link CSRs to ambitious outcome-based structural reform benchmarks to improve transparency and accountability and reduce excessive discretion. - Benchmarks should target euro area best practices to reduce structural gaps, foster convergence, and improve flexibility in factor markets. - Greater use of EU legislation where the EU has jurisdiction would strengthen implementation. - Support mechanisms: - Flexibility under the Stability and Growth Pact (SGP) for structural reforms, targeted use of European Structural and Investment (ESI) funds, and EU technical assistance (the 2015 Structural Reform Support Service) should support reform implementation. - Independent national competitiveness boards with a broad remit (as in Germany, the Netherlands, and Australia) could be created to help incorporate euro area-wide priorities into national reform agendas. - Authorities’ implementation views: - Broad agreement on reform priorities; progress has been significant in financial services and ALMPs, while regulatory reforms to strengthen the business environment, increase female labor market participation, and reduce barriers to competition in services have been slow. - The 2016 European Semester emphasizes removing barriers to investment via more efficient public administrations, lower regulatory burden for firms, improved regulatory frameworks in services and network industries, and effective insolvency regimes. - Trade developments: TTIP negotiations accelerated; a free trade agreement concluded with Vietnam; negotiations underway with some ASEAN countries. - Political economy of enforcement: - The EC prioritized effectiveness over enforcement, opting to use the “specific monitoring” tool rather than opening an EIP against countries with continued excessive imbalances, aiming to generate peer pressure for action. - The ECB suggested full and effective use of all instruments available under the MIP—including its corrective arm—could help spur reforms. - Introduction of reform benchmarks is progressing slowly due to the need for consensus among member states and data limitations in areas such as insolvency regimes. - The EC is analyzing benchmarking scope in insolvency frameworks and reducing regulatory barriers in the service sector; the number of CSRs was streamlined in 2016, complicating targeting of ESI funds to support reforms. *Source: IMF staff chapter text from _cr16219 - 0.4 percent by 2021, with real imports contracting* ### Box 3. Operationalizing Outcome-Based Structural Reform Benchmarks ### Box 3. Operationalizing Outcome-Based Structural Reform Benchmarks ### Context and objective - The Five President’s Report emphasizes the benefits of convergence of structural policies toward best practice in Europe. - In 2015, the Eurogroup agreed to benchmark the labor tax wedge to GDP-weighted EU averages for a single worker (in a budget neutral manner) as part of the European Semester. - Reform measures should be prioritized taking into account countries’ cyclical positions and policy space (paragraph 19). ### Selection criteria for benchmarks - Operational: - Benchmarks should be closely linked to the ultimate reform outcomes. - Benchmarks must be sufficiently concrete and measurable, directly under the control of policymakers, and enforceable. - Indicators should be selected from the existing pool of measures and data should be available at least on an annual frequency. - Indicators can be supplemented and improved over time. - Economic: - Benchmarks should focus on completing the single market and increasing product and labor market flexibility to improve the resilience of the monetary union. - Objective: facilitate faster adjustment to economic shocks, limit negative spillovers, and boost productivity so members can thrive independently within the monetary union. ### Six priority benchmarks (selected indicators) - The six indicators identified (selected in key reform areas) that meet the above criteria: - (i) OECD indices on regulatory barriers in professional services sectors; - (ii) the licenses needed to engage in retail trade; - (iii) employment protection in regular work contracts; - (iv) the labor tax wedge; - (v) the World Bank measure of the number of days to enforce a contract; - (vi) measures of public sector value added per employee. - For most selected indicators, OECD best practice lies within the euro area, making it a natural target for convergence. - Reforms with fiscal implications (like the labor tax wedge) could be implemented in a budget neutral manner and over a longer horizon, especially in countries without fiscal space. ### Example: labor tax wedge - Observation: - The average labor tax wedge for the euro area is higher than that in non-euro area OECD countries. - This higher wedge affects labor force participation and employment, particularly among the young, elderly, and women. - Empirical impact: - Reducing the labor tax wedge by 1 percentage point can raise output and employment by 0.8 and 1.2 percent respectively after 4 years. - Assessment: - The Eurogroup agreement to benchmark the labor tax wedge is a positive start, but the current target could be more ambitious as it remains above the euro area and OECD averages and far exceeds euro area best practice. --- ### Fiscal policy: promoting investment, rebuilding buffers, and improving fiscal governance - Fiscal stance and recent developments: - After several years of consolidation, the fiscal stance turned mildly expansionary in 2016. - Fiscal easing in 2016 is coming mainly from Germany, and to a lesser extent, Austria and Italy. - Beyond 2016, the overall fiscal stance for the euro area is projected to turn slightly contractionary as refugee-related spending wanes and others resume consolidation. - Fiscal space and adjustment: - Fiscal space is limited in many countries when taking into account debt sustainability, SGP targets, and national fiscal rules. - High debt constrains many countries; fiscal space is concentrated mainly in countries with small or no output gaps. - Pace of adjustment slowed in high debt countries from an average of 1.4 percent of GDP over 2010–12 to near zero over 2014–15. - Interest rate windfalls were largely spent rather than used to repay debt. - Policy recommendations: - Countries with fiscal space should use it to promote investment and structural reforms. - Countries without fiscal space should adhere to consolidation plans and rebuild buffers. - All countries should pursue growth-friendly fiscal rebalancing: boost public investment, reduce high marginal tax rates on labor and capital, and cut unproductive spending while broadening the tax base. - In a severe euro area-wide downturn, invoke the escape clause to suspend temporarily the fiscal adjustment required under the SGP. - Regional measures: - Expand centrally-financed investment schemes to lift near-term and potential growth (EFSI has approved over €100 billion in projects so far, mainly for the EU rather than targeted to the euro area). - Accelerate project approvals and disbursements and remove structural barriers to catalyze private investment. - Consider additional centralized investment schemes financed via an expanded EU budget or a new common fund for shared projects (digital single market, energy union, climate adaptation and mitigation, refugee settlement, transportation and communication networks). - Fiscal framework reform: - Strengthen enforcement of SGP rules and upgrade the fiscal framework. - Adopt a simpler framework with a single fiscal anchor and a single operational target. - Ensure the European Fiscal Board (EFB) is fully independent in assessing the aggregate fiscal stance and implementation of SGP rules, potentially by separating the EFB from the European Commission and ensuring strong ties with national fiscal councils through EUNIFI. - Medium-term integration: - Pursue further fiscal integration conditional on stronger compliance with fiscal rules and progress in structural reforms. - Options include a “rainy day” fund or a common unemployment insurance scheme that targets short-term unemployment to limit permanent transfers. - New centralized financial support should be conditional on adherence to fiscal and structural reform commitments to guard against moral hazard; some loss of sovereignty and treaty change would be required. --- ### Monetary policy: maintaining easing to guard against low inflation - Current stance and measures: - Monetary policy is appropriately accommodative and open-ended. - ECB’s March policy package: a further cut of all policy rates, an increase in monthly asset purchases to €80 billion (including for non-financial corporate bonds), and new targeted longer-term refinancing operations (TLTRO II); measures reaffirmed in June. - TLTRO II links borrowing rates to new lending to expand credit supply and mitigate negative-rate effects on bank margins. - Transmission and effects: - Asset purchases compressed sovereign term premia (term spreads have fallen by 50 basis points) and supported portfolio rebalancing; the euro depreciated by 6 percent in real effective terms since President Draghi’s Jackson Hole speech in August 2014. - Corporate issuance picked up after announcement of the corporate bond purchase program. - Bank lending rates have declined and credit picked up modestly; SME lending rates fell across the euro area and credit standards/conditions eased. - Full pass-through to the real economy can take time (experience from Japan 2010 and U.S. 2010); in the euro area credit growth turned positive after one year but remains weak. - Market functioning improvements: - Potential scarcity of some sovereign bonds under QE due to growing gap between ECB deposit rate and overnight German bund repo. - Recommend developing a common securities lending framework for NCBs and encouraging NCBs to lend securities via multiple central counterparties. - Further easing considerations: - Disinflationary pressures remain strong; 11 countries reported negative inflation in May. - Staff analysis suggests de-anchoring risks for inflation expectations have increased; greater sensitivity to inflation developments is needed. - Further deposit rate cuts face limits due to potential adverse effects on bank profitability; concerns greater in systems with high shares of variable rate loans and wide deposit bases (e.g., Italy, Portugal, Spain) and in surplus countries with concentrated excess reserves. - Additional easing should rely more on expanding asset purchases: - Staff analysis suggests an additional €2.4 trillion of assets after planned purchases through March 2017 would be available after applying limits and the ECB’s capital key. - A one-year extension of the program would be equivalent to about €960 billion in purchases. - Modest changes (e.g., allowing purchase of bonds with yields below the deposit rate) would increase the eligible pool and permit more even distribution across the yield curve. - Authorities’ views: - The ECB views current easing measures as effective in compressing term premia, easing lending standards, and reversing loan growth contraction. - The ECB calls for holistic assessment of negative rates’ impact on bank lending; valuation gains, improved asset quality, and TLTRO II can mitigate negative profitability effects. - The ECB supports enhanced securities lending programs across the Eurosystem to avoid collateral scarcity. - The ECB stands ready to ease further if needed to ensure inflation stays on the adjustment path; TLTRO II and CSPP implemented in June 2016 are expected to provide additional stimulus. --- ### Banking sector: repairing balance sheets and completing the Banking Union - Current challenges: - Bank profitability remains low due to anemic recovery, flattening yield curve, crisis legacies, and slow adaptation of business models (including fintech). - High NPL ratios in several countries (including Cyprus, Greece, Ireland, Italy, Portugal); large banks in France and Germany face high leverage. - Overbanking indicated by low price-to-book values and a large size of bank assets relative to capital markets. - Low investment returns have affected pension funds and life insurers, eroding ability to meet guaranteed commitments in some cases. - Pace of balance sheet repair: - Write-off rates increased in 2015 reducing NPL ratios for the first time since the global crisis, but pace remains too low given the stock of NPLs. - High NPLs inhibit credit growth, reduce bank profitability, and impair monetary policy transmission. - Waiting for a strong recovery to resolve NPLs is unrealistic; some recognition of losses is needed. - Staff analysis suggests in some countries banks would need to expand lending significantly under difficult conditions to offset drag on profitability from NPLs. - Comprehensive strategy to accelerate NPL resolution: - Incentivize faster resolution through stricter supervision: - More conservative provisioning and collateral valuation; - Capital surcharges; - Time limits on NPL disposals; - Restructure or liquidate nonviable banks. - The SSM should set aggressive time-bound NPL disposal targets following the EU stress test results that inform SREP. - Strengthen and harmonize corporate insolvency and foreclosure frameworks: - Shorten lengthy court procedures and encourage out-of-court arrangements to increase collateral value and close pricing gaps for NPL sales. - Promote active markets in distressed assets: - Develop distressed debt markets to facilitate NPL disposals. - Use private and publicly supported asset management companies (AMCs) to kick-start markets by facilitating sales of impaired assets to specialist investors. - In systemic cases where state intervention may be warranted, apply EU State Aid rules flexibly, recognizing difficulties in determining “market prices” without functioning markets. - AMCs should be open to foreign participation, including pan-European institutions, to assist funding and governance. *Source: _cr16219 - Box 3. Operationalizing Outcome-Based Structural Reform Benchmarks* ### 46. Completing the banking union requires establishing a common deposit insurance ### 46. Completing the banking union requires establishing a common deposit insurance ### Progress and remaining gaps - Single Resolution Mechanism (SRM) in place and Single Resolution Fund (SRF) financed after one year. - The final pillar — a common deposit insurance system — is still missing, leaving bank-sovereign risk links largely intact. - The European Deposit Insurance Scheme (EDIS), proposed by the EC in November 2015, is linked to member states’ implementation of the Deposit Guarantee Scheme Directive (DGSD) and envisages a gradually increasing insurance coverage. - Until banking sector risks have been reduced to the satisfaction of all member states, agreement on EDIS is likely to prove elusive. ### Risk sharing must be paired with risk reduction - Principle: Greater risk sharing should proceed hand in hand with measures to reduce banking sector risks to avoid moral hazard and unintended transfers; risk reduction alone does not provide a common backstop in systemic crises. - Recommended simultaneous measures: - Capital - Extend the recently announced agreement between the ECB and national competent authorities on national options and discretions to less significant institutions to further harmonize and strengthen the definition of capital. - Recovery and resolution - Differences in creditor hierarchies across countries in bank resolution should be clearly communicated to investors or a common hierarchy established to curtail bail-in surprises. - The SRB and national resolution authorities (NRAs) should deploy more quickly the BRRD’s minimum requirements for own funds and eligible liabilities (MREL) to clarify how bank losses could be absorbed. - Reduce regulatory uncertainty regarding new requirements to allow banks to plan for a smooth transition. - Supervisors and resolution authorities should test bail-in and cross-border coordination, especially for large and complex banks, to ensure BRRD functions smoothly in a crisis. - Sovereign exposures - Consider a more risk sensitive prudential treatment of banks’ sovereign exposures, phased-in gradually and following the guidelines of the international review being undertaken by the Basel Committee. - NPL resolution - Swifter resolution of non-performing loans (NPLs) is emphasized as part of risk reduction. ### Common fiscal backstop - A common fiscal backstop is required for effective risk sharing: - A credit line from the ESM is suggested as needed for both EDIS and the SRF to minimize chances that bank-sovereign risk links reemerge, particularly during the transition to full financing. - In times of systemic stress, the ESM could be empowered to engage in precautionary direct bank recapitalizations of viable banks to safeguard financial stability as allowed under BRRD, with the appropriate conditionality. ### Capital markets union and private risk sharing - Faster progress on the capital markets union would promote private risk sharing and non-bank financing: - Notable steps: changes to insurers’ capital for infrastructure investment under Solvency II; proposal for simple, transparent, and standardized (STS) securitization, which should be swiftly adopted. - Deeper institutional changes (e.g., harmonization of insolvency regimes) with a clearer timeline would be beneficial. ### Macroprudential policies and sectoral vulnerabilities - Macroprudential measures may be needed in some countries to address: - Nascent real estate bubbles (e.g., limits on loan-to-value ratios where house price appreciation is marked). - Weaknesses in the insurance sector: life insurers vulnerable to investment returns falling under guaranteed minimums; supervisors should encourage business models to shift away from heavy reliance on guarantees and monitor closely. - The ECB, though not vested with AML/CFT supervisory powers, could consider entering memorandums of understanding (MoUs) with designated national authorities to ensure effective AML/CFT supervision and cooperation in line with international standards. ### Authorities’ views on banking sector priorities - Agreed priorities: high NPLs and persistent low profitability require tailored approaches. - Banks have derisked in response to weak earnings and regulatory uncertainty, including by reducing correspondent bank networks. - To restore profitability banks should: - Grow non-interest income. - Reduce costs. - Adapt business models to tougher regulatory and supervisory environment. - ECB actions: request banks to implement tailored NPL reduction strategies and communicate plans; pace of NPL reduction likely gradual to mitigate market disruptions and credit squeeze. - Consolidation is needed, but should proceed via a mix of mergers, portfolio divestments, and exits based on sound business plans. - Expanding private risk sharing through a capital markets union is another avenue to improve robustness and reduce reliance on banks. - Concerns over moral hazard and possible transfers by some member states have held up progress on banking union; authorities cautioned against making risk reduction a precondition to completing the banking union and emphasized alignment of sovereign risk exposure steps with global standards. - Financial stability has improved with higher capital levels and more robust frameworks, but areas for close scrutiny remain: real estate and life insurance in some countries; challenges from low interest rates for life insurers and pension funds are seen as primarily medium-term issues. ### Synergies from a comprehensive, more balanced policy mix - Combining structural, fiscal, and monetary policies can generate important synergies: - Structural reforms raise potential output and strengthen the monetary union’s capacity to respond to shocks. - Faster NPL resolution enhances monetary policy effectiveness by unclogging the credit channel and reducing private debt overhangs. - Greater public investment by countries with fiscal space and growth-friendly fiscal policy would boost demand and supply, producing positive spillovers. - Centrally-financed investment schemes can overcome national fiscal constraints, provide targeted support without increasing national debt stocks, and support consolidation in high debt countries. - A collective effort to close output gaps more quickly would lift overall inflation, push down real interest rates across the area, and facilitate external rebalancing through relative price adjustments. ### Quantified macroeconomic scenario findings (EUROMOD exercise) - Scenario assumptions combined: - Continued monetary accommodation by the ECB. - Use of existing fiscal space including flexibility under the SGP amounting to around 0.4 percent of euro area GDP over 2017–18. - Centrally-financed investment in the euro area of around 1 percent of GDP for 2017–21 similar to the current EFSI, with some targeting to countries with larger output gaps. - Reduced credit risk premia from cleanup of bank balance sheets. - Implementation in 2018 of product and labor market reforms per the G20’s 2014 Comprehensive Growth Strategy. - Main findings relative to the April 2016 WEO: - Higher growth and inflation - Euro area growth would be 0.3 percentage point higher on average in 2017 and 2018, closing the euro area output gap by 2018—about two years earlier than currently projected. - By 2021, output would be 2.2 percent higher than the baseline. - Headline inflation would reach 2 percent by 2019 compared to a baseline of only 1.7 percent by 2021. - Stronger fiscal positions - Aggregate euro area public debt would be 3 percent of GDP lower by 2021, with declines larger in high debt countries (4 percent of GDP on average). - Fiscal deficits in these high debt countries would be about 0.4 percent of GDP lower each year. - External spillovers - The euro area’s current account surplus would decline to 2.2 percent of GDP by 2021, generating positive spillovers to the rest of the world. - Germany’s current account surplus would be an average of 0.3 percent of GDP lower each year. - Insurance value - A comprehensive approach provides insurance against stagnation; a similar coordinated response in a downside stagnation scenario would help maintain growth and policy buffers. ### Authorities’ views on comprehensive policy approach - Authorities find a more comprehensive policy approach desirable but difficult to achieve politically. - Limited appetite in countries with fiscal space to use it; creating new centralized mechanisms is politically challenging. - Political support for centralized initiatives would require stronger compliance with fiscal rules and progress in structural reforms. - Authorities noted potential gains could be lower if: - Inflation expectations become unanchored. - Costs from balance sheet cleanup are higher. - Structural reforms have a disinflationary impact (which could be mitigated by careful sequencing or complementary demand support). ### Staff appraisal: outlook, risks, and policy priorities - Current recovery and near-term outlook - The euro area recovery continues with stronger growth in recent quarters driven by domestic demand, low oil prices, a neutral fiscal stance, and accommodative monetary policy. - Exports have slowed in line with weakening external demand. - Inflation is extremely low, with disinflation in several countries and inflation expectations adjusting downwards. - External position - The euro area current account surplus rose further and is broadly consistent with medium-term fundamentals, but internal rebalancing has slowed; surpluses of some large creditor countries continue to grow. - Medium-term outlook - Steady but modest growth; weighed down by crisis legacies including high unemployment and NPLs in some countries. - Business investment, particularly by SMEs, recovering slowly; productivity remains well below pre-crisis levels. - With the output gap closing only slowly, inflation pressures expected to remain subdued, complicating adjustment for debtor countries. - Risks - Increased markedly: an external slowdown could disrupt the recovery. - Political risks from the refugee surge could endanger free movement of goods and services. - A “leave” or marginal “remain” vote in the U.K. referendum could heighten uncertainty and euroskepticism. - Policy recommendations and priorities - Ambitious structural reforms to raise potential growth and reduce macroeconomic imbalances. - Strengthen governance: CSRs linked to outcome-based benchmarks that are concrete, measurable and linked to reform objectives (examples: labor tax wedge, OECD indices on regulatory barriers in professional services, employment protection, other business climate indicators). - Progress towards benchmarks could be a precondition for accessing centrally-financed support. - Fiscal policy - Countries with fiscal space should use it to promote public investment and structural reforms; high debt countries should use interest savings from QE to reduce debt. - Expand centrally-financed investment schemes (e.g., enlarge the EFSI or establish new centralized funds for common projects such as the energy union, refugee settlement, climate adaptation and mitigation). - Over the longer term, a centralized fiscal capacity (such as a euro area treasury) would improve resilience to country-specific and common shocks. - Governance and credibility - Generate political support for centralized investment by strengthening SGP compliance and enforcement, simplifying fiscal rules, making enforcement more automatic, and establishing an independent European Fiscal Board. - Link access to centrally-financed investment schemes to SGP compliance and implementation of structural reform recommendations. - Monetary policy - Current stance is appropriately accommodative: March easing measures (scaled-up monthly purchases, corporate bond purchases, updated TLTRO) should ease financial conditions and expand credit. - Negative interest rates have helped lower bank funding costs, improve asset quality and ease lending standards, but disproportionately burden banking systems with large excess reserves. - Further rate cuts may unduly squeeze banks’ net interest margins, especially in countries more dependent on deposit funding and with large variable-rate mortgage portfolios. *Source: IMF staff report excerpt titled “46. Completing the banking union requires establishing a common deposit insurance” from the provided content unit.* ### 68. If the inflation outlook deteriorates or fails to converge more quickly to the anticipated ### _cr16219 - 68. If the inflation outlook deteriorates or fails to converge more quickly to the anticipated ### Monetary policy and asset purchases - If the inflation outlook deteriorates or fails to converge more quickly to the anticipated adjustment path, further easing would be warranted. - Further easing should come primarily from expanding the scope of asset purchases, which would allow scaling-up monthly purchases and/or extending the life of the program. ### Bank balance sheet repair and nonperforming loans (NPLs) - Bank balance sheet repair should be accelerated. - Bank profitability remains weak, reflecting the mediocre recovery, low rate environment, legacy problems and regulatory uncertainty. - The SSM’s NPL taskforce should act aggressively to set targets for banks to reduce their impaired assets. - NPL resolution should be accompanied by: - insolvency reforms; and - efforts to facilitate distressed debt markets, including through AMCs. - In systemic cases where state intervention may be warranted, the EU State Aid rules should be exercised flexibly as permitted. - NPL resolution could be part of a broader strategy to foster consolidation in the banking sector and facilitate the exit of nonviable banks. ### Banking union completion, deposit insurance, and capital markets - A common deposit insurance scheme (EDIS) and a common fiscal backstop are essential to complete the banking union. - In parallel with the implementation of EDIS, measures to reduce banking sector risks could be considered, including the prudential treatment of sovereign risk, which should be closely coordinated with global standards. - Further progress on the capital markets union could reduce risks by helping diversify financing sources and fostering greater private risk sharing. *Source: _cr16219 - 68. If the inflation outlook deteriorates or fails to converge more quickly to the anticipated* ### 71. It is proposed that the next Article IV Consultation on euro area policies take place on ### _cr16219 - 71. It is proposed that the next Article IV Consultation on euro area policies take place on ### Timing proposal - It is proposed that the next Article IV Consultation on euro area policies take place on the standard 12-month cycle. ### Main economic indicators (selected findings and projections) - Real GDP growth (percent): 2013: -0.3; 2014: 0.9; 2015: 1.7; 2016: 1.7; 2017: 1.7; 2018: 1.7; 2019: 1.5; 2020: 1.5; 2021: 1.5. - Private consumption growth (percent): 2013: -0.6; 2014: 0.8; 2015: 1.7; 2016: 1.7; 2017: 1.6; 2018: 1.6; 2019: 1.5; 2020: 1.5; 2021: 1.5. - Public consumption growth (percent): 2013: 0.2; 2014: 0.8; 2015: 1.3; 2016: 1.5; 2017: 1.1; 2018: 0.8; 2019: 0.6; 2020: 0.6; 2021: 0.6. - Gross fixed investment growth (percent): 2013: -2.6; 2014: 1.3; 2015: 2.9; 2016: 3.0; 2017: 2.8; 2018: 2.7; 2019: 2.6; 2020: 2.5; 2021: 2.5. - Exports growth (percent): 2013: 2.1; 2014: 4.1; 2015: 5.3; 2016: 3.2; 2017: 4.2; 2018: 4.2; 2019: 4.1; 2020: 4.1; 2021: 4.1. - Imports growth (percent): 2013: 1.3; 2014: 4.5; 2015: 6.1; 2016: 4.1; 2017: 4.6; 2018: 4.5; 2019: 4.3; 2020: 4.3; 2021: 4.4. - Potential GDP growth (percent): 2013: 0.5; 2014: 0.7; 2015: 1.0; 2016: 1.0; 2017: 1.1; 2018: 1.2; 2019: 1.3; 2020: 1.3; 2021: 1.4. - Output gap (percent): 2013: -2.9; 2014: -2.6; 2015: -2.0; 2016: -1.4; 2017: -0.8; 2018: -0.4; 2019: -0.1; 2020: 0.1; 2021: 0.2. - Employment growth (percent): 2013: -0.7; 2014: 0.6; 2015: 1.0; 2016: 1.1; 2017: 0.9; 2018: 0.7; 2019: 0.8; 2020: 0.7; 2021: 0.6. - Unemployment rate (percent): 2013: 12.0; 2014: 11.6; 2015: 10.9; 2016: 10.2; 2017: 9.8; 2018: 9.4; 2019: 9.0; 2020: 8.7; 2021: 8.5. - GDP deflator inflation (percent): 2013: 1.3; 2014: 0.9; 2015: 1.3; 2016: 1.0; 2017: 1.0; 2018: 1.2; 2019: 1.4; 2020: 1.5; 2021: 1.6. - Consumer prices inflation (percent): 2013: 1.3; 2014: 0.4; 2015: 0.0; 2016: 0.3; 2017: 1.2; 2018: 1.4; 2019: 1.5; 2020: 1.6; 2021: 1.7. - General government balance (percent of GDP): 2013: -3.0; 2014: -2.6; 2015: -2.1; 2016: -2.0; 2017: -1.7; 2018: -1.3; 2019: -1.0; 2020: -0.7; 2021: -0.6. - General government structural balance (percent of GDP): 2013: -1.2; 2014: -1.0; 2015: -0.8; 2016: -1.2; 2017: -1.2; 2018: -1.0; 2019: -0.9; 2020: -0.7; 2021: -0.6. - General government gross debt (percent of GDP): 2013: 93.4; 2014: 94.5; 2015: 92.9; 2016: 92.2; 2017: 91.2; 2018: 89.9; 2019: 88.1; 2020: 86.3; 2021: 84.2. - Current account balance (percent of GDP): 2013: 2.2; 2014: 2.5; 2015: 3.2; 2016: 3.1; 2017: 2.9; 2018: 2.7; 2019: 2.6; 2020: 2.5; 2021: 2.5. - EURIBOR 3-month offered rate (percent): 2013: 0.3; 2014: 0.1; 2015: -0.1; 2016: -0.3 (latest monthly available data for 2016). - 10-year government benchmark bond yield (percent): 2013: 3.3; 2014: 1.5; 2015: 1.2; 2016: 1.0. - U.S. dollar per euro exchange rate: 2013: 1.37; 2014: 1.23; 2015: 1.09; 2016: 1.13. - Nominal effective rate (2000=100): 2013: 108.4; 2014: 105.5; 2015: 101.4; 2016: 104.0. - Real effective rate (2000=100): 2013: 96.1; 2014: 91.3; 2015: 86.2; 2016: 87.6. ### External sector assessment — key findings and policy responses - NIIP trajectory: NIIP deteriorated to -17 percent of GDP in 2009 and recovered to around -4 percent of GDP in 2015; gross asset positions reached 225 percent of GDP and liabilities 229 percent of GDP in 2015. - Staff assessment: Projections of continued current account surpluses imply moderate improvement in NIIP-to-GDP ratio; gross positions remain sensitive to asset-price swings; some countries with sizeable net foreign liabilities remain vulnerable to a sudden stop in capital flows. - Overall assessment (2015): The external position of the euro area in 2015 was broadly consistent with the level implied by medium-term fundamentals and desirable policies. In 2016, the current account is projected to remain broadly unchanged. - Country-level adjustment needs: Net external creditors should strengthen domestic demand (reducing surpluses); net external debtors should raise productivity and competitiveness (raising surpluses or lowering deficits). - Potential policy responses: - Continue monetary accommodation to lift inflation closer to the ECB’s medium-term price stability objective and increase demand. - Complement monetary easing with policies to strengthen private sector balance sheets, structural reforms to enhance productivity and improve competitiveness, and more growth-friendly fiscal policy. - Fully use fiscal space where available to expand investment and promote structural reforms; those without fiscal space should continue consolidating. - Explore centralized investment schemes at the regional level to support growth. - A more balanced policy mix would boost domestic demand, lift inflation, rebuild policy buffers, and help reduce external imbalances within the euro area. ### Current account and real exchange rate assessments - Current account (2015): strengthened to 3.2 percent of GDP (cyclically adjusted 2.6 percent), up from 2.5 percent in 2014; two-thirds of improvement driven by higher energy balance from lower oil prices. - EBA model CA gap (2015): -0.3 percent of GDP with CA norm of 2.9 percent of GDP; staff assesses CA gap range for 2015 as -0.5 to 1.5 percent of GDP; underlying CA broadly consistent with fundamentals and policies. - REER developments: CPI-based REER depreciated by 8.6 percent from 2014 to 2015; as of May 2016, REER appreciated by 1.9 percent relative to 2015 average. - REER assessment (2015): EBA index REER model indicates overvaluation of 1.3 percent; level REER model indicates undervaluation of around 6 percent; CA regression model indicates modest overvaluation. Staff assesses euro area average REER in 2015 to be undervalued by 0–10 percent. - REER gaps within euro area: range from undervaluation of 10-20 percent in Germany to overvaluation of 5–10 percent in Spain. ### Capital and financial accounts; reserves - Financial flows (2015): rise in CA surplus mirrored by net financial outflows; financial account deficit driven predominantly by portfolio debt outflows partly offset by portfolio equity inflows. - Assessment: Capital outflows reflect easing financial conditions due to ECB accommodation; reducing outflows depends on improving domestic growth prospects and institutional and structural reforms to raise potential growth. - FX intervention and reserves: euro has status of a global reserve currency; reserves held by euro area economies typically low relative to standard metrics but the currency is free floating. ### Risk Assessment Matrix — selected risks, likelihoods, impacts, and policy responses - Structurally weak growth in key advanced and emerging economies relative to baseline: - Likelihood: High. - Expected impact: High. - Policy responses: Ease monetary policy to raise inflation and support demand; repair bank, corporate, and household balance sheets; use fiscal space within SGP framework and consider centralized investment and fiscal rebalancing; accelerate structural reforms; invoke systemic escape clause in SGP in adverse scenario. - Significant slowdown in China and other large emerging market economies: - Likelihood: Low-Medium. - Expected impact: Medium. - Policy responses: Slower export growth implies need for monetary and fiscal support and structural reforms (see above). - Persistently lower energy prices: - Likelihood: High. - Expected impact: High (downward pressure on inflation; somewhat higher growth from disposable income gains). - Policy response: Further monetary accommodation (ECB asset purchases) to address lower inflation and risk of deflation. - Heightened risk of fragmentation/security dislocation in Europe (including Brexit risk from June 23, 2016 referendum): - Likelihood: High. - Expected impact: High. - Policy responses: Rapid refugee integration into host labor markets; collective reform of EU common border and asylum policy; temporary refugee-related fiscal costs accommodated case-by-case; contingency planning for market volatility; reinforce economic integration and cooperation across EU. - Sharp asset price decline and decompression of credit spreads: - Likelihood: Medium. - Expected impact: Medium. - Policy responses: Accelerate balance sheet repair; ECB to continue asset purchase program and focus on price stability objective. - Euro area insurance sector stress from low interest rates: - Likelihood: Medium. - Expected impact: Medium. - Policy responses: Restrict guarantee-based products in favor of unit-linked instruments; encourage alternative long-term, higher-yielding investments subject to supervision; periodic review under Solvency II and system-wide stress testing. ### Structural reform plans and progress (selected countries) - France — reform priorities: - Reform government spending to reach medium term fiscal objective; improve labor market functioning; increase competition in service sectors; pursue business-friendly policies. - Recent progress: Pension reform in 2014–15; targeted expenditure reviews; Responsibility Pact social security cuts; CICE tax credit; labor market and competition liberalizations (Macron law, Rebsamen law). - Staff recommendations: Limit general government spending growth to inflation; institutionalize spending reviews; reverse growth in public employment; further raise effective retirement age; tighten caps on local taxes and borrowing; improve targeting of social benefits; change minimum wage formula; reduce disincentives for SMEs to grow; align regulated savings rates to market rates. - Germany — reform priorities: - Increase labor force participation (women, older workers, refugees); increase productivity and competition in services; clarify energy policy. - Recent progress: Extended child care provision; review of professional regulations; measures to broaden access to training for refugees; competition in rail sector; measures to improve venture capital environment; draft bill prioritizing underground cables; removal of financial disincentives to work after pensionable age. - Staff recommendations: Lower tax wedge for low-skilled and women; improve child care provision; increase retirement ages; facilitate labor market integration of low-skilled migrants; further deregulate professional services; strengthen regulator powers in rail and postal services. - Greece — reform priorities: - Preserve and expand labor market flexibility; foster competition in services and product markets; improve business environment. - Recent progress: OECD recommendations largely completed; opening up some restricted professions; independent review of labor market frameworks underway. - Staff recommendations: Preserve recent labor market reforms; keep subminimum wage for youth; align collective dismissal and industrial action frameworks with EU best practices; continue opening regulated professions; implement pending OECD recommendations; overhaul licensing system. - Italy — reform priorities: - Raise public sector efficiency; civil justice and insolvency reform; labor market reform; increase competition. - Recent progress: Enabling law on public administration reform (2015); judicial reforms and procedural improvements; insolvency procedure reforms; Jobs Act (Dec 2014) implemented in 2015; Annual Competition Law under discussion. - Staff recommendations: Implement and monitor public administration reform; improve civil justice efficiency; decentralize wage setting; strengthen competition authority; enhance competition across sectors and implement existing legislation. - Portugal — reform priorities: - Alleviate impediments to external competitiveness and potential growth; improve labor and product markets. - Recent progress: Mandated planning unit for structural reforms; halted public transport concessions; renegotiated TAP privatization terms; one-time levy on GALP lowering gas prices; new by-laws for services and professions; new Budgetary Framework Law adopted in 2015 (implementation delayed). - Staff recommendations: Revisit and implement reforms; preserve recent structural reforms; promote managerial skills and inclusive labor support; avoid excessive minimum wage increases; upgrade public services and administration; continue reducing energy costs and strengthen market integration at European level. - Spain — reform priorities: - Address labor market duality and high structural unemployment; boost productivity and competitiveness for small firms; facilitate private sector deleveraging. - Recent progress: 2012 labor reform; slow progress on Active Labor Market Policies; ongoing Market Unity Law implementation; insolvency regime improvements. - Staff recommendations: Ensure wage growth in line with productivity and external competitiveness; use firm-level wage bargaining; close dismissal-cost gap between temporary and permanent contracts; strengthen ALMPs and training; reduce regulatory burden and liberalize professional services; facilitate private sector deleveraging via legal reform and improved insolvency frameworks. ### Structural reform benchmarks (high-level findings) - Euro area countries have significantly higher regulatory barriers in professional services than other OECD countries. - Reducing regulatory barriers in professional services can increase output and employment over the medium-term. - The average labor tax wedge in the euro area is well above the OECD average; labor tax wedge cuts can boost output and employment. - Public sector efficiency in the euro area lies well below the OECD average; improving public sector value added can improve output and employment. ### Fiscal near-term stance scorecard (selected country snapshots, 2015 and 2015-16 indicators) - Euro area aggregate: - Real GDP growth: -2.0; Output gap: 0.5; Unemployment: 10.9; Real GDP growth (WEO baseline) 1.6; GG debt: 93; MT primary gap: 2.4; Overall change from baseline: -2.0; Structural gap: -0.9; Debt deviation over baseline: -0.2; Under IMF advice: 0.14; EC deviation: 0.37. - Selected countries (2015 & 2015-16 indicators, partial): - Germany: Real GDP growth: -0.1; Output gap: 0.1; Unemployment: 4.6; Real GDP growth (WEO baseline) 1.5; GG debt: 71; MT primary gap: 3.0; Overall change from baseline: 0.6; Structural gap: 0.7; EDP triggered? No. - France: Real GDP growth: -2.2; Output gap: 0.2; Unemployment: 10.4; Real GDP growth (WEO baseline) 1.1; GG debt: 97; MT primary gap: 1.3; Overall change from baseline: -3.6; Structural gap: -2.1; EDP triggered? Yes. - Italy: Real GDP growth: -3.3; Output gap: 0.8; Unemployment: 11.9; Real GDP growth (WEO baseline) 0.8; GG debt: 133; MT primary gap: 2.6; Overall change from baseline: -2.6; Structural gap: -0.8; EDP triggered? No. - Spain: Real GDP growth: -3.5; Output gap: 0.9; Unemployment: 22.1; Real GDP growth (WEO baseline) 3.2; GG debt: 99; MT primary gap: 1.0; Overall change from baseline: -4.5; Structural gap: -2.4; EDP triggered? Yes. - Note: Table 5 provides a scorecard approach with thresholds for tightening, neutral, and stimulus recommendations across debt sustainability, output, output gap, unemployment, real GDP growth, GG debt, MT primary gap, 10-year bund spreads, EDP triggers, and deviations from MTO. *Source: IMF staff, aggregation of WEO projections and IMF country teams as presented in the euro area policies chapter.* ### 0.5 to 1 ### 0.5 to 1 ### Annex I. The Impact of Negative Interest Rate Policy on Bank Profitability - Transmission and market response - Money markets in the euro area adjusted to modestly lower deposit rates on banks’ excess reserves under the ECB’s negative interest rate policy (NIRP), indicating the zero lower bound is less binding than previously thought. - Negative policy rates have passed on to the wider economy by lowering lending rates for both firms and households. - Risks to bank profitability and pass-through - Sticky deposit rates could diminish bank profitability and impair pass-through to lending rates. - Transmission of a lower negative marginal policy rate to lending rates reduces bank profits from intermediation unless deposit rates can adjust downwards. - Some banks offset declining interest income with higher lending volumes, lower funding costs via capital markets, lower provisioning and capital gains from investments. - There is likely to be a lower bound below which disintermediation occurs, especially in countries with high shares of variable rate loans and high dependence on deposit funding, such as Italy, Spain, and Portugal. - Excess bank reserves facing a negative ECB deposit rate are concentrated in banking systems of surplus countries. - Quantified impact and required lending growth - The combination of NIRP and the recently expanded asset purchase program lowers NIMs of euro area banks in 2016 by 11 basis points on average. - Based on staff analysis, aggregate lending would need to increase 2.3 percent annually (up from 1.8 percent at end-January) for banks to maintain current profitability over the amortization period of their current loan book. - The calculation ignores possible improvement in asset quality and increase in asset prices associated with monetary easing. - Role of TLTRO II - The ECB’s TLTRO II may mitigate the potentially adverse impact of NIRP on bank profitability by granting banks access to cheap funding, facilitating pass-through of the marginal policy rate to the wider economy. - Lower funding costs through TLTRO II would benefit only new lending and does not offset the negative impact of asset re-pricing on existing loans. - In some countries, current lending growth remains low and falls below the required benchmark to access TLTRO II funding at the most favorable terms. - Empirical and graphical findings (as presented) - Annual Loan Growth Required to Maintain Net Interest Margin, end-2015: required loan growth (with TLTRO II effect)* vs. current loan growth (y/y, Jan. 2016). - ECB TLTRO-II Benchmarking: Net Lending to Non-Financial Corporates and Households, Dec. 2014-Jan 2016 (Percent) shows current net lending (Jan. 2016, y/y) and required threshold for cheapest ECB funding 1/ (Net lending growth required to qualify for TLTRO II borrowing at the ECB deposit rate (-0.4%)). - Text figure conclusions: banks in selected economies will likely reprice lending quicker than deposits, reducing margins; lending margins have compressed most in countries with high asset re-pricing and stickier deposits; higher levels of underprovisioned impaired assets weigh on capacity to maintain NIMs; current loan growth in selected economies is insufficient to offset the impact of declining margins. - Notes and data assumptions - Estimates based on the historical pass-through of policy rates and the elasticity of net interest margins to changes in term premia between Jan. 2010 and Feb. 2016; total mortgage and corporate loans at end-2015 to EA residents. - Scenario assumes an increase of monthly asset purchases (until Sept. 2017) by the ECB and a deposit rate cut of 10bps (as per ECB decision on March 10). - */ assumes that new lending is fully funded using TLTRO-I funds at a weighted average borrowing rate of -20bps. ### Annex II. Can European Banks Grow out of their Problems? - NPLs and balance sheet constraints - Current stock of NPLs for the euro area declined marginally to €900 billion as of end-June 2015 (down from €932 billion or 9.2 percent of GDP at end-2014), and still more than double the level in 2009. - NPL ratios are elevated in Cyprus, Greece, Ireland, Italy, and Portugal. - Limited capital buffers and low profitability (owing to weak loan demand and compressed interest margins) undermine banks’ capacity to clean up balance sheets and support economic recovery. - Profitability of new lending (staff analysis) - Analysis of 34 banks in euro area countries with elevated NPLs shows current lending would be profitable for most banks even under the assumption of forward-looking provisions calibrated to expected losses implied by firm-specific credit risk weights. - The weighted average net RoE is positive for banks in Ireland, Italy, and Spain; banks in Portugal have a negative average net RoE. - Italian banks are profitable on average at a net RoE of 0.7 percent, but some of the 15 Italian institutions in the analysis—accounting for about 15 percent of the banking sector (in terms of total outstanding loans)—would incur losses from new lending due to a relatively high cost of risk. - If reported provisioning under IAS 39 is applied, the number of loss-making banks in Italy declines to three (accounting for about 5 percent of the outstanding stock of loans in Italy). - Impact of ECB credit easing (TLTRO II) on profitability - In a sensitivity analysis where sample banks access TLTRO II as of June 2016 and cease to remunerate deposits (reducing average funding cost to the ECB’s marginal refinancing rate of 0 percent), bank profitability from lending would improve in all euro area countries. - The average net RoE of Portuguese banks would turn positive; however, lending would remain unprofitable for five Italian banks (presenting about 7 percent of the total loan volume of sample banks). - Scenario-based assessment for Italian banks - Baseline scenario: banks would make profits from new lending over the next five years at an average net RoE of 3.8 percent, even under more conservative provisioning; additional provisioning cost of legacy loans would remain a considerable drag on expected profitability. - Stagnation scenario: average net RoE declines to 0.9 percent. - Downside scenario: average net RoE declines to -5.5 percent. - Lending rates and funding costs were aligned to projected changes in short-term and long-term interest rates, after accounting for funding mix at end-2015; procyclicality of credit risk used to forecast provisioning changes consistent with staff estimates. - Capital buffers and potential loan growth - Current monetary easing measures could lower the NIM by up to 7 basis points on average during the first half of 2016. - Aggregate lending growth would need to increase to at least 2.4 percent annually (or about 0.6 percentage point above current credit growth) for banks to maintain current profitability over their loan amortization period. - Assuming no change to current capitalization and credit quality of loan portfolios, only a few banks hold surplus capital in excess of the regulatory minimum. - Capital constraints are highest in countries where new lending seems more profitable, such as Spain (and to a lesser extent in Italy). - Potential Loan Growth Exhausting Available Capital Buffer (CAR) chart shows estimated potential loan growth (percent) and cumulative share of gross loans in the banking sector (percent) for IRE, ITA, ESP, PRT under assumptions described. - Assumptions on regulatory minimum and capital buffer - The regulatory minimum is defined as the bank-specific capital requirement defined by the ECB’s Supervisory Review and Evaluation Process (SREP). - Capital buffer is calculated as the difference between CAR and a minimum capital requirement of 12.7 percent (based on Pillar I (4.5 percent), capital conservation buffer (2.5 percent), and Pillar IIA and IIB requirements of 2.7 percent and 3.0 percent, respectively), subject to a structural capital buffer of 2 percentage points. ### Policy recommendations and actions (selected) - Monetary policy - If inflation and inflation expectations fail to pick up as expected, the ECB should extend the ECB’s asset purchase program. - Priority should be on credit easing measures over further interest rate cuts. - To facilitate access to high-quality collateral, develop a common securities lending framework for NCBs, similar to the ECB’s own lending framework; encourage NCBs to lend securities via multiple central counterparties. - Actions taken - The ECB increased the issue share limited to 33% (from 25%) in September 2015; extended in December the asset purchase program (APP) to March 2017, or beyond, if necessary; included bonds issued by public sector agencies in the purchase program (and widened eligibility of agency debt twice since inclusion); decided to reinvest principal payments on maturing securities for as long as necessary. - In March 2016, a corporate sector purchase program (CSPP) and a new series of four targeted longer-term refinancing operations (TLTRO II) were launched (and started in June), and the monthly purchase was expanded to €80 billion (up from €60 billion). - Fiscal policy - Use fiscal space and flexibility within the SGP to support investment and structural reforms. - To rebuild buffers and stimulate investment, countries should pursue more growth-friendly fiscal reforms. - At the regional level, expand centrally-financed investment schemes to lift near-term and potential growth. - 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. - To restore credibility and rebuild trust, enhance the fiscal framework through simpler rules with more automatic enforcement and an independent fiscal board. - Rapid implementation of the EFSI to boost investment; the European Fund for Strategic Investment (EFSI) has approved over €100 billion in projects so far, mainly in energy. - Fiscal actions taken and next steps - Countries with fiscal space have used it partially to expand refugee-related spending and public investment. - Discussions are ongoing on focusing the fiscal framework; accelerate project approvals and disbursement for EFSI. *International Monetary Fund — EURO AREA POLICIES (excerpts provided in source content).* ### Appendix I. ### Appendix I. Progress Against IMF Recommendations ### Financial Policies - 2015 Article IV policy advice: - Complete the banking union by ratifying SRF and accelerating its funding; establishing a pan-European deposit guarantee scheme (DGS); and putting in place a common fiscal backstop for the banking union. Additionally, a relaxation of ESM direct recap preconditions could be considered. - Harmonize bank supervisory treatment and the definition of bank capital across the banking union. - Develop a comprehensive strategy for NPL resolution, combining more assertive supervision, structural reforms to enforcement and insolvency regimes, and measures to develop a market for distressed debt. - Push forward with a capital markets union (CMU), including promoting high quality securitization and removing national differences in capital market infrastructure and regulations. - Actions since 2015 Article IV: - SRF was ratified in November 2015, but a faster timeline for mutualization was not agreed. - A proposal for a European deposit insurance scheme (EDIS) was put forward by the EC in October 2015 but is stalled due to objections by some member states. - There have been no changes to ESM direct recap preconditions. - An ECB regulation on harmonizing options and national discretions (ONDs) was published in March 2016. - Write-off rates of NPLs increased in 2015, and the stock of NPLs declined for the first time since the global financial crisis. - The ECB’s NPL Task Force completed its data collection on countries’ and banks’ NPL management practices. There are plans to issue NPL reduction targets for identified banks. - The EC’s legislative proposal for simple, transparent, and standards securitization (STS) from December 2015 is now awaiting approval by the European Parliament. - As part of the CMU Action plan issued in September 2015, the EC put out a “call for evidence” on the EU regulatory framework for financial services to assess overlaps and gaps and the cumulative impact of legislation on cross-border transactions. - Next steps / policy recommendations: - The EDIS and a common fiscal backstop are essential to the long-term viability of the banking union. ESM direct recap conditions may need to be relaxed in a systemic crisis. - Remaining areas of national discretion in banking supervision should be harmonized, including those related to the use of macroprudential instruments such as loan-to-value ratios. - Continue to incentivize NPL resolution through stricter supervision, faster insolvency regimes, and deeper markets for distressed assets. In systemic cases, apply EU State Aid rules for public support flexibly. - A more ambitious timeline for capital markets union, including a faster harmonization of insolvency regimes and other deeper institutional changes to create a more integrated capital market. ### Structural Policies - 2015 Article IV policy advice: - Structural reform priorities at the national level should include labor market reforms to reduce duality and increase employment opportunities, as well as product and service sector reforms to improve the business climate. - At the regional level, faster implementation of the Services Directive, further improvements to insolvency regimes, and a greater push toward a single market in capital, transport, energy, and the digital economy would help further integration. - A more effective governance framework would help advance structural reforms, including via using outcome-based structural reform benchmarks. - Actions since 2015 Article IV: - Ongoing. Overall, significant progress on financial services and ALMPs, while regulatory reforms to strengthen the business environment and employment, increase female labor market participation, and reduce barriers to competition in the services sector have been slow. - A new single market strategy for the services sector has been developed since late 2015 in response to the slow implementation of the Services Directive. - There has been progress in implementing the necessary measures to complete the single market in capital, energy, transport, and digital commerce. - The negotiations for TTIP are ongoing. - In December 2015, the Eurogroup agreed to benchmark euro area member states' tax wedge on labor for a single worker at average wage and a single worker at low wage against the GDP-weighted EU average. Benchmarks on service sector regulation and insolvency are being developed. - Compliance with the 2015 Country Specific Recommendations (SCR) under the European Semester has worsened relative to that for 2013-14 CSRs. The Excessive Imbalance Procedure was not recommended once again even though several member states have been found to have excessive imbalances for two consecutive years. - Next steps / policy recommendations: - Reform priorities include: reducing entry barriers in the professional and retail sectors; improving the efficiency of public administration; and strengthening insolvency regimes; shrinking the labor tax wedge; expanding cost-effective active labor market policies (ALMPs); credible commitment to reducing protections for regular workers and scaling back excessive unemployment benefits. - Faster progress in completing the single market in services, energy, digital commerce, and transport and an ambitious TTIP is needed. - To improve enforcement, the 2016 European Semester and MIP should link CSRs to ambitious outcome-based structural reform benchmarks. Suggested benchmarks include: OECD indices on regulatory barriers in professional services, the number of licenses needed to engage in retail trade, employment protection in work contracts; the World Bank measure of the number of days to enforce a contract, and public sector value added per employee. - To better incentivize structural reforms, the economic governance framework needs to be strengthened significantly. The EIP should be opened for repeat offenders. *Source: Appendix I. Progress Against IMF Recommendations (IMF staff text reproduced in the provided content)* ### Appendix II. 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 European statistics produced by the two systems are of sufficient coverage, quality, and timeliness for effective macroeconomic surveillance. - This appendix provides an update on developments of statistical issues since the previous Article IV consultation with the euro area member states. ### Transition to new international statistical standards - All member states now compile national accounts according to the European System of National and Regional Accounts (ESA 2010). 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 as regards the instrument breakdown within the various functional categories, and have full stock-flow reconciliation. - Monetary and financial statistics (e.g., interest rates, investment funds, financial vehicle corporations, securities issues) methodology has been adapted and new statistics with more detailed breakdowns have been available since July 2015. ### Flash quarterly GDP estimates - Flash quarterly GDP estimates are now published at T+30 days. - On April 29, 2016, Eurostat began publishing preliminary flash estimates of quarterly GDP for the euro area (EA) and for the European Union (EU) about 30 days after the end of the quarter (t+30). - The methodology mainly follows the current methodology for the GDP flash estimates published 45 days after the end of the quarter (t+45). - Because of the earlier timing, data for the third month of the quarter often have to be (at least partially) estimated by member states. ### Significant initiatives to improve quality and timeliness - Harmonised Indices of Consumer Prices (HICP) and House Price Index: - A new basic legal act on HICP and the House Price Index entered into force. It provides HICP flash estimates for all euro area member states by the end of each reference month, and indices at the sub-class level (level 5). - In May 2016, the owner-occupied housing price index was released for the first time. It is a quarterly index based on the ‘net acquisition’ approach. - EU KLEMS Productivity and Growth Accounts: - DG ECFIN is funding two revised and updated versions covering 34 industries, all EU 28 economies, several EU-aggregates, Japan, and the United States. - Phase I (from December 2015 to July 2016) will lead to publication of the updated EU KLEMS database starting with 12 countries and covering 1995–2014. - FIGARO project (Full International and Global Accounts for Research in Input-Output Analysis): - Aims to establish annual production of EU multi-country input-output tables and a five-yearly production of EU multi-country supply, use, and input-output tables. - First deliverables are experimental EU-IC-SUIOT for the year 2010, to be available in summer 2017. - Framework Regulation Integrating Business Statistics (FRIBS): - Significant progress in drafting FRIBS, which will expand coverage of services sectors and global value chains and improve timeliness and quality of business and trade statistics. - FRIBS will integrate international trade statistics, both on goods and services, with business statistics to better serve National Accounts and Balance of Payments in the area of international trade in services. - EuroGroup Register (EGR): - Based on microdata sent by National Statistical Offices, more than 60,000 enterprise groups are now part of this register. - The EGR is increasingly used for the production of European business statistics (such as the Foreign Affiliates Statistics—FATS). - Harmonization of trade data: - Further harmonization of data on trade of goods and services is under way, addressing discrepancies between national accounts, balance of payments statistics, and international trade statistics, with largest gaps observed in imports and exports of goods. - European Wheel of Competitiveness (EWoC): - Collaborative project between Eurostat and DG Joint Research Centre to build a statistical reference framework for competitiveness analyses across macro-economic, micro-economic, globalization, environmental and socio-institutional dimensions. - Data are to be disseminated in the second half of 2016. - Quality–Adjusted Labour Input (QALI) and capital indicators: - Eurostat and DG Joint Research Centre developed the QALI index and capital indicators, including time series for net fixed capital stock, gross fixed capital formation and average service life of assets. ### Modernization of intra-EU trade in goods statistics - Two projects SIMSTAT and REDESIGN were completed. SIMSTAT proved technical and statistical feasibility of micro-data exchange on intra EU exports; REDESIGN identified costs, benefits, and risks of modernization options. - Work is now under way to elaborate a proposal per strategic orientation provided by EU member states in May 2016, preparing concrete implementation including exchange of micro-data. ### Government finance statistics (GFS) and public sector accounting - Annual and quarterly ESA 2010-based GFS time series are available for all countries. - Revisions to government deficit and debt levels due to introduction of ESA 2010 occurred in October 2014, largely due to reclassification of units in the general government sector. - Quarterly non-financial accounts data by subsector of general government are now being collected under the ESA framework. - All countries supply detailed COFOG data. - Eurostat began publishing data on contingent liabilities and non-performing loans of the government in February 2015 in the context of the “Six-Pack”. - Technical work is ongoing to harmonize and modernize public sector accounting standards by moving to accruals based accounting in the context of the EPSAS project. An interim technical report is scheduled for the first half of 2016. ### EPSAS (European Public Sector Accounting Standards) - The first EPSAS Working Group meeting took place in Malta in September 2015. - The EPSAS Working Group is intended to establish a more permanent forum for public sector accounting standard-setters and technical experts in Europe. - Discussions concern development, introduction and operation of EPSAS in the mid-to-longer term. - The Commission/Eurostat are providing support for accruals implementation of the International Public Sector Accounting Standards (IPSAS) to member states. - Ongoing technical work includes first time implementation guidance for accruals accounting, accounting definitions, governance and accounting principles, and public sector specific issues such as tax revenue, relief for small and less risky entities, heritage, or pensions. ### Effect of the European Fund for Strategic Investments (EFSI) on GFS - The EFSI regulation includes a declaration by the Commission regarding the treatment under the Stability and Growth Pact of Member State contributions; the declaration does not change reporting rules but recalls application of existing rules. - It is expected the Commission will undertake case-by-case assessments. - It is possible that EFSI transactions will be included in government deficits, although this impact would be excluded by the European Commission for the purposes of the Excessive Deficit Procedure, in line with its communication on flexibility in early 2015. - Investments undertaken in the context of EFSI, including Public-Private Partnerships, will be analyzed under the statistical rules in force (ESA 2010 Regulation). *Source: Appendix II. Statistical Issues (IMF staff text reproduced in the provided content)* ### 8. Ongoing efforts aim to enhance statistics for the Macroeconomic Imbalances ### _cr16219 - 8. Ongoing efforts aim to enhance statistics for the Macroeconomic Imbalances ### Macroeconomic Imbalances Procedure (MIP) Scoreboard and data coverage - Eurostat published the indicators for the Macroeconomic Imbalances Procedure (MIP) Scoreboard in November 2015. - The MIP Scoreboard provides the statistical basis for the annual Alert Mechanism Report released by the European Commission at the start of the European Semester. - Main challenges: - Availability of historical time series of sufficient length based on the new statistical standards. - Majority of countries, together with the ECB and Eurostat, are working to calculate the main historical balance of payments series according to the new standards. - Improvements and extensions: - Data coverage for the ten-year timespan needed for the 2016 Statistical Annex was improved substantially, though some gaps remain. - Domain coverage increased from the 2015 release: three new labor market headline indicators added — the activity rate, the youth unemployment and the long term unemployment. - The new labor market indicators are based on Labor Force Survey results and already cover the needed 10-year span time. ### ESS–ESCB quality assurance framework for MIP statistics - ESS and ESCB continue to work closely to ensure the quality of MIP-relevant statistics and have developed a quality assurance framework. - Practical arrangements for operationalizing cooperation consist of three elements: - (i) An annual high-level ESS-ESCB quality assessment report on statistics underlying the MIP indicators (“level 1”) prepared by Eurostat and the ECB (the first report was prepared in 2015). - (ii) Progressive alignment and harmonization of Quality Reports produced across domains by the ESS and the ESCB in their respective fields of competence (“level 2”) — this action is ongoing. - (iii) Publication of condensed country specific reports on the quality and statistical processes of statistics underlying the MIP indicators (“level 3”) — these reports have already been published for the balance of payments and international investment position. ### ECB projects to enhance availability and quality of statistics - Money Market Statistical Reporting (MMSR) - ECB Regulation (ECB/2014/48), adopted in November 2014, implemented in spring 2016. - The 52 biggest credit institutions in terms of balance sheets report daily on individual transactions relating to various segments of the money market. - Transaction-by-transaction coverage includes: - (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; - (iii) daily foreign exchange swaps (FX swaps) transactions and overnight index swaps transactions denominated in euro (volume and rates). - ECB developed a common set of reporting instructions fully compliant with the ISO 20022 standard. - Some aggregated indicators will be released to the public in early 2017. - Securities holdings statistics - Collected since end-2013. - Data contain quarterly information on holdings of individual securities by institutional sectors, collected after 70 days from euro area (and some other EU) national central banks, and include reference issuer and securities information from the ECB Centralized Securities Database (CSDB). - A second module comprises security-by-security information on holdings by 26 individual euro area banking groups identified as important for stability and functioning of the financial system in the euro area. - Granularity provides breakdowns on issuer and holder sides not available in other statistics. - Starting in 2016, timeliness of data collection on individual banking groups reduced to 55 days. - It is envisaged to increase, as of 2018, the reporting population to all institutions directly supervised by the ECB. - Insurance corporations’ statistics - ECB regulation (ECB/2014/50) adopted in November 2014 requires insurance corporations to report quarterly their balance sheets beginning in May 2016, covering data starting with the first quarter of 2016. - Granularity and expected quality comparable to balance sheet statistics of other financial institutions collected under ECB regulations. - Annual data on premiums, claims, and commissions will be reported. - To limit reporting burden, national central banks may use harmonized European supervisory reports (“Solvency II”) to compile the statistics. - The first release of the statistics is planned for January 2017. - They will replace the current, non-harmonized ECB insurance corporations statistics, which will continue to be compiled until the second quarter of 2016. - Harmonized granular credit data (AnaCredit Project) - Aims to establish a long-term framework governing collection of harmonized granular credit and credit risk data to support ESCB tasks: monetary policy analysis and operations, risk management, financial stability surveillance, and macro-prudential policy. - Information provided by Central Credit Registers, maintained by the NCBs or similar granular statistical databases. - In December 2015, the ECB published the AnaCredit draft regulation; public comment period to end January 2016. - Amended draft regulation approved by the Governing Council in May 2016 (ECB/2016/13). - First reporting expected in mid-November 2018 based on data as of September 2018 and will focus on credit granted to legal entities (non-financial and financial corporations, and governments). ### Supervisory statistics and reporting enhancements - The Supervisory Statistics Division within the ECB’s Directorate General Statistics covers governance for management of data from all supervised groups and individual institutions, including coordination, receipt, quality management, and reconciliation of supervisory data. - Entry into force in 2014 of the EBA’s Implementing Technical Standards (ITS) on supervisory reporting significantly increased comparable information on capital adequacy and financial positions. - Framework now includes additional data on forbearance and non-performing loans (with uniform definitions), asset encumbrance, liquidity and leverage. - In March 2015, the ECB published Regulation (ECB/2015/13) on supervisory financial information, gradually extending reporting requirements to all supervised entities not yet reporting on the basis of ITS supervisory financial reports (FINREP), with the rollout starting at end-2015. - Data collection follows a “sequential approach”: banks submit data to national supervisors, who then report to the ECB, which in turn disseminates selected data to stakeholders. ### Survey on Access to Finance of Enterprises (SAFE) - Latest results published on 1 June 2016. - Report covers changes in financial situation, financing needs and access to financing of small and medium-sized enterprises (SMEs) in the euro area in the six months from October 2015 to March 2016, and compares SMEs with large enterprises. - An ad hoc set of questions on the level of liquid assets was included in this round. - Key findings: - SMEs reported increased willingness of banks to provide credit at lower interest rates and signaled a further improvement in the availability of external sources of finance. - Finding customers remains their main concern; access to finance was the least important problem, though results differ across countries. - Next larger survey round (in cooperation with the European Commission) covering all EU countries and neighboring countries will be published on 30 November 2016. ### Data standards and dissemination - The ECB and Eurostat supported the launch in November 2014 of the Special Data Dissemination Standard plus (SDDS Plus), the third and highest tier of the IMF’s Data Standards Initiatives. - Six euro area countries (and nine EU member states) adhere to the SDDS Plus. ### Supplementary information: Brexit referendum effects and updated forecasts - On June 23, the people of the United Kingdom voted to exit the European Union. - Market reactions and near-term developments: - The euro depreciated against the US dollar by 2.2 percent as of July 1 but was broadly unchanged in nominal effective terms. - Sovereign yields initially rose in some countries but significantly declined during the week following the referendum (with the exception of Greece and Portugal) as German Bund yields reached record lows. - Equity markets in the euro area initially fell but have since recovered to around 5 percent below their pre-referendum level. - Bank share prices fell by 17 percent, with sharper drops in Greece, Ireland, and Italy. - Little evidence to date of market dysfunction: liquidity has not dried up, and most financial prices have recovered partially from post-vote troughs. - Actions and willingness of the Bank of England, the ECB, and other central banks to backstop liquidity contributed to stabilization. - Trade and economic linkages: - The U.K. is the destination for about 13 percent of euro area exports and has close financial links with the region. - U.K. exit expected to negatively affect euro area economies through trade, financial and confidence channels. - Revised staff projections (reflecting the referendum): - Staff now project euro area real GDP to grow by 1.6 percent this year and 1.4 percent next year, somewhat lower than the staff report projections. - Inflation revised downward slightly in light of slower growth. - Forecast table (values provided as in source) - Staff report - Real GDP (percent): 1.7, 1.7, 1.7 - Inflation (percent): 0.3, 1.2, 1.4 - Preliminary forecast update - Real GDP (percent): 1.6, 1.4, 1.6 - Inflation (percent): 0.2, 1.1, 1.2 - July 1, 2016: Uncertainty to persist until U.K.’s new status vis-à-vis the EU is clear; risks to the outlook remain firmly on the downside and are mainly political. - Staff recommendation: collective actions to improve governance of the economic union and make it more cohesive remain valid and have increased urgency. ### External Sector Assessment and policy implications - Net international investment position (NIIP) - Background: NIIP of the euro area deteriorated to -17 percent of GDP in 2009, but recovered to around -4 percent in 2015. - Improvement driven by stronger current account balances and modest nominal GDP growth. - Gross positions: rebounded since 2009, reaching 225 percent of GDP for assets and 229 percent of GDP for liabilities in 2015. - Assessment: projections of continued current account surpluses suggest NIIP-to-GDP ratio will continue to improve at a moderate pace, while gross positions will likely remain sensitive to swings in asset prices. - Some countries with sizable net foreign liabilities remain vulnerable to a sudden stop in capital flows. - Overall Assessment for 2015: - The external position of the euro area in 2015 was broadly consistent with the level implied by medium-term fundamentals and desirable policies. - In 2016, the current account is projected to remain broadly unchanged. - Policy implications and potential responses: - Continued monetary accommodation is appropriate to lift inflation closer to the ECB’s medium-term price stability objective, which should also help increase demand and facilitate relative price adjustments at the national level. - Monetary easing should be complemented with policies to strengthen private sector balance sheets, structural reforms to enhance productivity and improve competitiveness, and more growth-friendly fiscal policy. - Countries should fully use fiscal space where available to expand investment and promote structural reforms; those without fiscal space should continue consolidating. - At the regional level, centralized investment schemes should be explored to support growth. - A more balanced policy mix would better boost domestic demand, lift inflation, and rebuild policy buffers, helping to reduce external imbalances, including within the euro area. - Current account - Background note fragment: "The current account (CA) balance for the euro area strengthened in 2015 to 3.2 percent of GDP (cyclically adjusted" *Source: IMF staff estimates.* ### 2.7 percent), up from 2.5 percent of GDP in 2014, with two-thirds of the improvement reflecting a higher energy balance ### _cr16219 - 2.7 percent), up from 2.5 percent of GDP in 2014, with two-thirds of the improvement reflecting a higher energy balance ### Current account developments and assessment - Finding: The euro area current account (CA) increased to 2.7 percent, up from 2.5 percent of GDP in 2014, with two-thirds of the improvement reflecting a higher energy balance from lower oil prices. - Finding: The CA increase was broad based but reflects different drivers at the national level: - Debtor countries (e.g., Spain and Portugal): improvement during the crisis mainly through import compression; more recently external competitiveness gains from price and wage adjustments have strengthened these current accounts. - Creditor countries (e.g., Germany): surpluses continue to grow, reflecting still-weak investment and stronger fiscal positions. - EBA model estimate: CA gap of -0.2 percent of GDP for 2015, with a CA norm of 2.9 percent of GDP. - Staff assessment: Taking into account additional factors and uncertainties, the CA gap for 2015 is assessed to be in the range of -0.5 to 1.5 percent of GDP, leaving the underlying CA broadly consistent with the level implied by medium-term fundamentals and desirable policies. ### Real exchange rate (REER): background and assessment - Background: - The CPI-based REER depreciated by 8.6 percent from 2014 to 2015, reflecting the euro area’s weak cyclical position, lower inflation, and accommodative monetary policy. - Compared to the 2015 average, the REER has appreciated by 1 percent as of June 2016. - The euro depreciated in the days after the U.K. decided to exit the EU; this decision does not affect staff’s external assessment for 2015. - Model results and staff judgment: - EBA index REER model: overvaluation of 1.2 percent. - Level REER model: undervaluation of around 6 percent. - CA regression model using standard trade elasticities: 1 percent overvaluation. - Staff on balance: euro area average REER in 2015 assessed to be undervalued by 0-10 percent. - Cross-country REER gaps: - Germany: undervaluation of 10-20 percent. - Spain: overvaluation of 5-10 percent. - Policy implication: Large differences in REER gaps highlight the need for debtor countries to improve external competitiveness and for creditor countries to boost domestic demand. ### Capital and financial accounts: flows and policy measures - Background and findings: - The rise of the CA surplus in 2015 was mirrored by net financial outflows. - The financial account deficit was driven predominantly by portfolio debt outflows, partly offset by increases in portfolio equity inflows. - Assessment and policy implications: - Trend of financial flows closely follows current account developments. - Capital outflows arise in the context of easing financial conditions due primarily to the ECB’s monetary accommodation. - Reducing capital outflows will depend on improving domestic growth prospects and on institutional and structural reforms that strengthen the resilience of the EMU and raise potential growth. ### FX intervention and reserves - 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 background notes (as provided) - 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. - CA and REER gap assessments for the euro area are derived from GDP-weighted averages of 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. ### Authorities' statement: policy priorities and assessments (July 6, 2016) - Near-term outlook and risks: - Recovery in its fourth year; economic activity exceeds the pre-crisis peak. - Supportive factors in 2016: low oil prices and the euro, accommodative monetary policy, and slightly expansionary fiscal policy for the euro area as a whole. - Growth hampered by crisis legacies, low potential growth, slowing emerging market growth (including China), slow global trade expansion, and elevated geopolitical and policy-related uncertainty. - The UK referendum outcome has materialized as an important political risk, increasing urgency for a convincing policy response. - Authorities agree that uncertainty and downside risks to the growth outlook have increased. - Banking union and banking sector repair: - Progress: supportive monetary policy and banking union steps have improved financial conditions; banks strengthened capital and liquidity buffers; lending rates declined and credit growth turned positive. - Remaining challenges: non-performing loans (NPLs) remain elevated in some Member States; need a comprehensive strategy combining supervisors, national and potentially European policy makers; revisit legal and institutional frameworks (foreclosure and bankruptcy laws, supervisory treatment of provisioning and NPLs, market rules for distressed loan sales, tax rules). - Banks need to restore profitability through non-interest income growth, cost reduction, and adapting business models; further consolidation is needed in several countries. - Authorities broadly share staff's views on completing the Banking Union; next steps outlined in the roadmap endorsed by the June Ecofin Council. - Capital Markets Union and investment promotion: - Progress toward Capital Market Union; new rules to support insurer and reinsurer investment in infrastructure. - Legislative proposal to restart securitization markets agreed by Member States in December 2015; proposal to simplify prospectus requirements presented. - European Fund for Strategic Investments (EFSI) expected to have mobilized investments of over EUR 106 billion in 26 Member States. - European Investment Project Portal launched on 1 June 2016. - Commission will propose an extension of EFSI beyond the initially planned time horizon of 3 years, subject to thorough assessment. - Any additional "centralized investment schemes" would need careful assessment; an experts group will consider issues in relation to the second stage under the Five Presidents’ Report. - Fiscal framework and recommendations: - Fiscal policy should reflect economic conditions and sustainability risks at Member State level, while ensuring effective coordination and compliance with European fiscal rules. - Fiscal adjustment in structural terms came to a halt in 2015 at the euro area level. - For 2016 a slightly expansionary fiscal stance is expected for the euro area, before turning broadly neutral in 2017. - Fiscal effort should be differentiated by Member State in compliance with the Stability and Growth Pact (SGP). - Scope to improve tax system efficiency and reduce the tax wedge on labor; reduce insufficiently productive expenditure. - Predictable, transparent, and consistent application of the SGP is key; Commission and Member States discussing ways to improve transparency, predictability, and reduce complexity; options to increase reliance on a single operational target are being explored. - Countries with high debt should preferably use windfall gains from lower interest payments to make further progress in improving debt positions. - Monetary policy and price stability: - ECB monetary policy remains supportive and has eased financing conditions and supported credit creation. - Additional monetary stimulus expected from measures still at an early stage, notably the corporate sector purchase programme (CSPP) and the second wave of targeted longer-term refinancing operations. - ECB will act using all instruments within its mandate to achieve price stability if warranted. - Monetary policy must be complemented by solid public finances and structural reforms. - Structural reforms and governance: - Well-designed and sequenced structural reforms can have sizable positive medium-term impact on potential growth and enhance adjustment capacity. - Short-term impact maximized if determined implementation boosts confidence; coordinated implementation can produce higher gains and positive spillovers with fiscal and monetary policy. - Member States advanced reforms over the last year but pace was slower and uneven across countries. - Progress concentrated in financial services and active labor market policies; much remains to be done in business environment, labor market functioning, and reducing barriers in services. - 2016 European Semester emphasizes removing barriers to investment, improving the business environment and productivity, making public expenditure more supportive to growth, and improving employment, human capital, social inclusion and protection. - Commission initiatives to reinforce the Single Market: develop a Capital Markets Union; further deepen the Single Market for goods and services; create a Digital Single Market; improve Single Market in transport and energy. *Source: IMF staff and authorities' statements, euro area Article IV consultation materials included in the provided content.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16219.pdf_