Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

IMF Survey : Euro Area Uncertainty Holds Back Stronger Recovery in Germany

August 6, 2013

  • Strong fundamentals underpin Germany’s role as anchor of stability in Europe
  • But uncertainty about euro area weighs significantly on German activity
  • Reviving growth in Germany tied to sustained reduction in this uncertainty

Despite strong fundamentals, heightened uncertainty about the euro area—more so than about Germany itself— is holding back more robust growth in Germany, the IMF said in its annual report on the country.

Sled maker in Boehen, Germany. Small German businesses postponing investment due to euro area uncertainty (photo: Christof Stache/Newscom)

Sled maker in Boehen, Germany. Small German businesses postponing investment due to euro area uncertainty (photo: Christof Stache/Newscom)


In spite of supportive domestic financial conditions and robust corporate balance sheets, a sharp slowdown last year and into early 2013 is mainly due to negative spillovers from recession in the euro area amplified by uncertainty about prospects and policies in the region.

“A stronger recovery in Germany hinges on a durable reduction of euro area uncertainty,” said Subir Lall, Assistant Director of the European Department, and the IMF’s mission chief for Germany. “In this sense, the circumstances for the German economy have changed. Last year Germany seemed relatively immune to developments in the rest of the euro area,” added Lall.

According to the IMF’s assessment of Europe’s largest economy, the rebound that started in 2010 gave way to weakening momentum during the course of 2012 when growth fell below potential. While exports to destinations outside Europe began to recover by mid-2012, exports to the rest of the euro area continued to decline as the deep recession in the region continued. Consumption remained a bright spot, buoyed by strong wage growth.

Drag on business investment

Financial stress in the euro area has abated, in part due to decisive and timely policy actions by major central banks. However, policy uncertainty at the euro area level is still perceived as high, and uncertainty in Germany is closely linked to that of the region.

This sensitivity of German businesses to euro area uncertainty is one of the most important reasons to postpone investment and adopt a wait-and-see attitude for many small and medium-sized enterprises despite easy financing conditions.

Looking ahead, “economic activity in Germany is expected to be weak in 2013,” emphasized Lall. The German economy is projected to expand at around 0.3 percent in 2013. A gradual pickup in activity projected towards the end of the year is conditional on a further and tangible reduction in this uncertainty and a gradual recovery in the rest of the euro area.

Deficit goals achieved

Against the backdrop of globalization, Germany has become increasingly sensitive to economic developments in the region and the rest of the world. An important source of risk is a possible re-emergence of financial stress in Europe, which could interact with already weak demand and uncertainty, to amplify the impact on the German economy through both trade and financial channels. These risks could be further compounded by weaker global growth prospects in part related to slower economic activity in major emerging markets.

“In the current low-growth environment, the modest loosening of the fiscal stance this year is appropriate,” stated Lall. Germany has already achieved deficit goals at the federal level well ahead of schedule, and the general government balance is in line with European commitments. “However, given the weak growth environment and significant risks to the outlook, it will be important to avoid over-performing on consolidation, as has been the tendency in recent years” added Lall.

According to the IMF’s assessment, other key near-term policy priorities include

Further strengthening the banking system. While the overall soundness of the banking systems has improved, there are vulnerabilities related to exposures to specific sectors such as shipping, international commercial real estate, and certain foreign asset holdings.

Sustaining financial reform momentum both domestically and at the regional level. Domestic priorities are further augmenting capital buffers, improving profitability and efficiency of the financial system, and facilitating the adjustment of business models ahead of new international and European regulatory requirements. It is also important that the surveillance of large cross-border banks be firmly anchored by strong domestic supervision and close coordination with key financial centers' supervisory authorities. At the supranational level, helping articulate a clear, harmonized, and coherent roadmap toward achieving domestic and European financial sector initiatives would help alleviate a major question mark over the European financial system.

Anchor of regional stability

Germany’s safe haven status and strong balance sheets provide a buffer against external shocks for the region, and therefore, in this capacity, Germany acts as a regional anchor of stability.

“Germany also plays a pivotal role in the development of policies and the evolving architecture of the European monetary union,” said Lall. Clearly articulating the shared vision for closer economic and financial integration among euro area member countries would provide a crucial anchor to the longer-term expectations of households, firms, and the financial system.

Faster reforms can raise growth

Efforts to support the economy’s growth potential need to be sustained. Recent initiatives to counteract the decline in the labor force are welcome, but further steps toward lowering the tax burden, increasing the availability of childcare, and facilitating migration, as well as identifying and addressing disincentives to having children, should continue.

Further efforts to accelerate pan-European integration and the harmonization of energy and transportation networks, as well as reforms to improve the productivity of the services sector and to broaden the sources of financial intermediation, could also help.