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Transcript of a Conference Call on Germany with Juha Kahkonen, Deputy Director of the IMF’s European Department and Conny Lotze, Deputy Chief of Media Relations
July 12, 2011
MS. LOTZE: Good morning, everybody. This is Conny Lotze from External Relations, and this is a conference call on the Article IV consultations with Germany. You've seen the documents. I hope you all had access to the documents under embargo on the Online Media Briefing Center.
I have with me here the Deputy Director of the European Department, Mr. Juha Kahkonen, and he is going to be on the record. I will give the floor over to him for some introductory remarks on the key messages of this report and then we'll take your questions. Juha, the floor is yours?
MR. KAHKONEN: Thank you, Conny, and good morning or good afternoon to the participants.
The German economy is doing well. It grew 3 1/2 percent last year and we are expecting growth of 3.2 percent this year. Germany has recovered all the employment and output losses from the global financial crisis and it's now in a position that most advanced countries can only dream about.
Yet all is not well going forward. The current high growth rates mask the fact that potential growth, the growth rate that Germany can expect to grow at in the medium-term remains in our assessment still at about 1 1/4 percent and Germany can do better.
The main message that we have in this year's consultation is that by taking action, taking policy measures, Germany can raise its growth in the medium term in a way that makes domestic demand contribute more than until now to growth, and if this happens this would be very good for Germany which would have higher and more stable growth rates because the economy would be less dependent on exports. But it would also be good for Europe and the global economy because Germany would then play a bigger locomotive role for the European and global economies.
What are the actions that we have in mind? Growth comes from three sources: labor, investment, and productivity; and we think economic policies in Germany can be strengthened to create bigger contributions from all these three sources.
In the area of labor, we think that labor-force participation has room to increase in Germany. The demographic trends in Germany are not good. The working-age population is peaking this year and next and there will be a gradual but significant decline in the working-age population. In this situation it would be very helpful if Germany was able to raise its participation rates to levels that exist currently in the Nordic countries. This would significantly counteract the demographic impact from the decline in the working-age population.
Regarding investment, it's probably not well known that Germany's problem is not savings that are out of line, but it's actually investment rates that are low by advanced country standards. So there's scope to put in place policies that would raise German investment rates.
In terms of productivity, there is scope for policies that would enable more innovation. Germany has great talent but there are difficulties getting ideas to the marketplace and implementing them. Concretely, the policy measures that we see as helping labor participation, investment and productivity, there are three areas, tax policy, education, and innovation.
On tax policy, our main recommendation is to find ways to increase labor-force participation and raise the investment rate. Tax reform should aim to encourage groups where employment rates can be increased, namely women, lower-income groups, and the elderly to stay in the labor market. We are not in favor of generalized tax relief, but targeting groups where the potential for higher participation rates is the greatest. Increased labor-force participation would also increase the incentives to invest, but we would also advocate further easing of corporate taxes to help stimulate investment.
In terms of education, Germany has already done a lot, but we think there is more needed to strengthen early childhood care and education and also to strengthen Germany's vocational training system to ensure lifelong learning so that skills would remain up to date through people's careers.
On innovation, one area where Germany is lacking is making venture capital more widely available. The traditional banking sector is not currently meeting that need and there are ways and obstacles that could be removed. Other reforms that we recommend include improving the insolvency rate regime and creating better mechanisms for universities to bring their ideas to the marketplace.
The final area that I would like to cover is the financial system which was scrutinized this year as in all G-20 countries, the so-called FSAP, Financial Sector Assessment Program, and the basic finding is that the German financial system is broadly stable but there are pockets of vulnerability. Improved capital ratios at banks imply that they could absorb considerable stress. Nevertheless, German banks are highly leveraged, have low profitability and the large banks remain highly dependent on market funding. The vulnerabilities apply in particular to certain financial institutions, most prominently some Landesbanken. In the financial sector we also think improvements could be made in earlier publication of data and improving transparency.
What action are we recommending in the financial sector to limit systemic risk? We see four areas requiring attention:
One, there is still a legacy from the global financial crisis and it requires attention. Viable segments should be carved out from the distressed banks and returned to private hands. And the distressed assets should be sold at a deliberate pace avoiding fire sales.
Second, clarity is needed in the regulatory and supervisory regime. There is a so-called Ten-Point Plan being discussed that would move supervision more to the Bundesbank and make it responsible for macroprudential oversight and we would see that as important to put this plan in place as soon as possible.
On deposit insurance, Germany has a fairly unique system of individual deposit insurance schemes for each pillar of the banking system. We think efforts could be made to eventually unify these to realize economies of scale.
Finally, on the savings banks, Sparkassen, these obviously have done quite well during the crisis but we would caution against complacency because similar things were said about the Landesbanken in the past and they have clearly turned out to have weaknesses and there are clearly close connections between the Sparkassen and Landesbanken and in an environment where there is going to be more international competition over time, we would see a need over time to shift the savings banks gradually to private ownership while making sure that their public functions are carved out.
These are the basic messages, and I'll be happy to take questions.
QUESTIONER: I would like to get an updated perspective on perceived spillovers back into Germany from what's happening elsewhere in the Eurozone. Looking at BIS data on exposure to German banks in Italy and Spain, the numbers start to get really big and I'm wondering what concerns you have about contagion coming back into Germany and what might happen in coming months in that regard? Secondly, a quick question for Conny. When are the Italy and Spain Article IV Staff Reports going to be released?
MS. LOTZE: I'll get to those later. I'll let Juha answer first.
MR. KAHKONEN: Given its current account surpluses, Germany is a big investor and its foreign assets are primarily invested in Europe. Its foreign assets are highly concentrated in the Euro Area where there's a gross exposure of almost 120 percent of GDP. However, the exposure of German banks to Greece, Ireland, and Portugal is only about 4 percent of German GDP or about 1 1/2 percent of German banking system assets. The numbers for Spain and Italy are larger. I don't have them handy.
The numbers here show that the direct impact of contagion from the three countries is small but, of course, like for other countries, depending on what kind of contagion there is and what kind of overall distress there is, the impacts could be larger, but I don't want to speculate.
MS. LOTZE: As to your question on the staff reports, Italy's should be coming out fairly soon. It could be even today. I'll keep you posted. Spain is only in the Board for discussion next week, so it's going to take another week or a little bit longer. Next question, please.
QUESTIONER: I would be interested in knowing what the reason for the significant upward revision for this year's growth forecast is.
MR. KAHKONEN: It's like all other forecasters. The first quarter growth number for this year was a positive surprise and all forecasters basically revised their projections upward. It's not that we see the underlying trend differently, but it's just that the year started exceptionally well.
QUESTIONER: If nobody else is in queue: I was surprised at the discussion of Germany's sort of long- and medium-term growth potential, 1 to 1 1/4 percent, which we always associate with the periphery countries. I'm wondering, I know this is a little bit abstract, but what would the Eurozone look like if Germany collapses to that growth potential of 1 percent?
MR. KAHKONEN: Let me just focus on Germany. One should keep in mind that in per-capita terms it's not insignificant given that there is very little population growth in Germany, and of course there are countries that have lower potential growth, but we wanted to emphasize during this consultation that the current very high numbers in our view are a cyclical phenomenon.
There was a big drop in output during the crisis and it's only natural that there's a strong pick-up. Consumption is roughly where it was before the crisis, but investment is still significantly below where it was before the crisis, and so we think that growth will return to this potential growth rate with roughly the same potential growth rate as before the crisis. So it's not that things have gotten worse, but it's just that Germany had a particularly impressive recovery from the crisis.
QUESTIONER: So no commentary on the larger issue of what the EMU looks like with a Germany growing at 1 percent?
MR. KAHKONEN: No. There will be a Euro Area discussion covering the pan-European issues.
MS. LOTZE: The Euro Area Article IV will also be in the Board.
MR. KAHKONEN: Next week.
MS. LOTZE: Next week. Yes. So you'll get that full report afterwards. Are there any other follow-up questions or any questions?
QUESTIONER: Since there seems to be nobody else on the line, I'll ask one more. I'm wondering given the results of the FSAP and this Article IV, what are we expecting vis-à-vis the stress tests coming up?
MR. KAHKONEN: We are not privy to the results of the European stress tests, and like others, we are waiting with interest to see what they are. The FSAP results suggested that overall the system is quite strong, but there are pockets of vulnerability, so we'll see later this week what the European stress tests show.
MS. LOTZE: If there are no further questions then we'll end the conference call here. Thank you all for participating and dialing in so early or late in the afternoon depending where you are. Thank you very much.
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