2014 Article IV Consultation with the Euro Area Concluding Statement of the IMF Mission
IMF News, June 19, 2014
Source details
- Canonical URL
- 2014 Article IV Consultation with the Euro Area Concluding Statement of the IMF Mission
Other formats
Bibliographic details
- Published: June 19, 2014
Overview
- Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
- Date: June 19, 2014.
Major findings on the recovery and macroeconomic conditions
- The euro area recovery is taking hold:
- Real activity has expanded for four consecutive quarters.
- An incipient revival in domestic demand is adding to the impetus from net exports.
- Financial market sentiment has improved dramatically, particularly after the recent ECB measures.
- Sovereign and corporate yields are now at historic lows in many countries, and lower funding costs have helped banks raise more capital.
- Strong policy actions have boosted investor confidence and laid the foundations for recovery:
- National: progress in repairing sovereign and bank balance sheets and pursuing structural reforms to restore competitiveness.
- Area-wide: collective commitment to the EMU, progress on building a banking union.
- ECB: a wide range of measures to support demand and address fragmentation; the ECB’s Comprehensive Balance Sheet Assessment to be completed later this year is encouraging recapitalization and helping boost confidence in the banking system.
- Recovery weaknesses and risks:
- The recovery is neither robust nor sufficiently strong.
- Activity and investment have yet to reach pre-crisis levels; private investment recovery weaker than in most previous recessions and financial crises.
- In the first quarter of 2014, growth was weaker than expected and unevenly distributed across countries.
- Balance sheets are still impaired and debt levels elevated; public debt levels remain high.
- Weakness in banks’ balance sheets inhibits the flow of credit and corporate and household debt overhangs impede demand.
- Inflation is worryingly low, including in the core countries; very low inflation keeps real interest rates and real debt burdens elevated, stifling demand and growth and complicating relative price and real wage adjustment.
- Unemployment is unacceptably high:
- The average rate for the euro area is around 12 percent.
- Youth unemployment averages close to 25 percent.
Quantified imperatives and context
- Much higher growth is needed to bring down unemployment and debt.
- With the benign market environment, now is the time to implement reforms to increase growth.
- Policy efforts should focus on three areas:
- (1) demand support;
- (2) balance sheet repair and completion of the banking union; and
- (3) the advancement of structural reforms.
Policy recommendations — Providing more demand support
- The ECB’s recent actions:
- Signal determination to address low, below-target inflation and fulfill its mandate.
- Collectively, the measures should lead to a substantial expansion of liquidity.
- Provision of targeted term funding for banks should encourage credit growth in stressed economies.
- If inflation remains stubbornly low:
- The ECB should consider a large-scale asset purchase program, primarily of sovereign assets according to the ECB’s capital key.
- Expected impacts: boost confidence, improve corporate and household balance sheets, stimulate bank lending; potential to have a significant impact on demand and inflation.
- Fiscal stance:
- After several years of consolidation, the overall fiscal stance for the euro area is close to neutral.
- This strikes the right balance between demand support and debt reduction.
- Large negative growth surprises should not trigger additional consolidation efforts.
Policy recommendations — Mending balance sheets and completing the banking union
- ECB Comprehensive Assessment and bank recapitalization:
- Progress on the Comprehensive Assessment has been encouraging.
- Banks have already raised substantial capital in anticipation of the Asset Quality Review (AQR) and associated stress tests.
- The ambitious timetable for recapitalization of banks should be feasible given markedly improved market conditions.
- The ECB should continue to urge banks to be proactive in raising capital.
- Banking union progress:
- Transition to the Single Supervisory Mechanism (SSM) will facilitate cross-border liquidity provision, reducing fragmentation.
- Single Resolution Mechanism (SRM) decision-making procedures have been simplified.
- The timetable for mutualization of the Single Resolution Fund (SRF) has been shortened.
- Remaining gaps and recommendations:
- Work needs to continue to establish a common backstop to sever effectively sovereign-bank links.
- The current planned backstop may prove insufficient to break decisively bank-sovereign links.
- The proposal for ESM direct recapitalization is a step in the right direction, but as currently envisaged, the thresholds for such support are too high.
- Centralized resolution resources may not be sufficient to handle stress in large banks.
- Corporate debt overhang:
- Working out the corporate debt overhang would help spur investment.
- Many countries have taken steps to reform their insolvency regimes; these efforts need to continue, together with progress on harmonizing national insolvency frameworks.
- Measures should be taken to facilitate out-of-court settlements, reduce impediments to debt restructuring, and introduce guidance on resolution procedures in line with international best practices.
Policy recommendations — Advancing structural reforms
- General objectives:
- More structural reforms are necessary to revive investment, employment, and productivity, and to reduce imbalances.
- National reforms to improve labor market functioning and increase competition in product and service sectors need to progress further.
- Area-level supportive actions:
- Implement the Services Directive.
- Negotiate free trade agreements.
- Further integrate energy markets to mitigate possible disruptions in global commodity markets due to geopolitical events.
- Addressing intra-euro area imbalances:
- Further policy efforts in both creditor and debtor economies are necessary to ensure that intra-euro area imbalances do not re-emerge as the recovery takes hold.
- In particular, higher infrastructure investment in creditor economies and further strides in improving competitiveness in debtor economies would be needed.
- Tackling youth unemployment:
- A comprehensive strategy requires measures to boost growth and remove country-specific structural impediments.
- Specific measures: reducing the tax wedge to lower hiring costs; bringing minimum wages more in line with average labor costs to avoid pricing the youth out of the labor market; better-targeted work-related training programs to align skills with job opportunities.
- Capital market development:
- Encourage capital market financing alternatives—such as greater securitization for corporate funding—to ensure lending to viable small firms and reduce reliance on banks for credit.
- Example: reducing regulatory capital charges for high-quality securitization structures would free up banks capital for further lending.
- Fiscal governance over the medium term:
- Ideas that simplify and strengthen the fiscal governance framework should be explored.
- Successive reforms of the SGP have introduced many positive elements, but the system has become excessively complicated with multiple objectives and targets.
- Compliance with fiscal targets has been poor, reflecting in part weak enforcement mechanisms; concern that the framework discourages public investment.
- Consideration should be given to a simpler framework with a single objective and an economically sound operational lever (example offered: debt reduction as the ultimate fiscal objective and the structural balance as the single operational target).
- Credibility of the rules would be enhanced by much stronger enforcement mechanisms.
- Boosting the ability of the center to fund public infrastructure projects—such as cross-border investments in transportation, communications, and energy networks—would help lay the foundations for sustained growth while keeping countries within the bounds of the fiscal framework.
Summary conclusion
- Concerted policy efforts are needed to strengthen the recovery:
- Continued demand support is vital to address low inflation.
- The favorable market environment provides a window of opportunity to make further progress on repairing balance sheets and advancing structural reforms.
- Together, these will create the conditions for higher growth, job creation, and a durable recovery.
2014 Article IV Consultation with the Euro Area Concluding Statement of the IMF Mission (June 19, 2014).