Transcript of a Conference Call on Germany Article IV Consultation

August 7, 2013

Washington, D.C.
Tuesday, August 6, 2013

MR. SILVESTRE: I’d like to welcome all of the participants to this presentation of the staff report for the 2013 Article IV Consultation with Germany. With me today is the mission chief for Germany, Mr. Subir Lall. That’s S-U-B-I-R, family name L-A-L-L. And before I pass the floor to him let me remind you of two things. First, everything you got yesterday, all the documents you received, plus this conference call are still embargoed for another hour, until 10:00 Washington Time. That’s 1400 GMT. And, also, everything you hear now is on the record and Mr. Lall can be quoted.

Subir, you have the floor.

MR. LALL: Thank you, Bruno. Good morning, ladies and gentlemen. Thank you for joining us on this call.

This is at the end of the 2013 Article IV Consultation for Germany and I’d like to begin by making a few brief remarks, following which I’d be happy to take your questions.

First, we maintain our forecast of 0.3 percent growth in 2013 for Germany and 1.3 percent in 2014. This is the forecast that we had made in early June. Developments since then have been broadly in line with our assumptions. Our focus on this year’s consultation has been on taking a look at the fundamentals of Germany, including the balance sheets of the private and public sectors, and, on the basis of that, assessing the role these fundamentals play in both Germany and for the region, both from the point of view of long-term, long-run patterns and also near-term dynamics.

We find that Germany’s fundamentals remain strong, including public household and corporate sector balance sheets. In conjunction with this, financing conditions for households and firms also remain comfortable in Germany. Nevertheless, credit growth in Germany has been excessive as corporate have ample cash and household incomes have been rising at a healthy pace, reflecting the strong labor markets. These strong fundamentals also underpin Germany’s role as an anchor of stability in Europe.

The question then is why overall growth, and investment in particular, has been sluggish since last year in Germany? In spite of supportive domestic financial conditions and robust corporate balance sheets that I refer to, the sharp slowdown last year and into early 2013 is mainly due to negative spillovers from the recession in the euro area, amplified by uncertainty about prospects and policies in the region. In fact, our assessment is that uncertainty about euro area prospects and policies, more so than about Germany itself, is holding back more robust growth in Germany. In this sense, circumstances have changed since last year’s Article IV consultation. At that time, Germany seemed relatively immune to developments in the rest of the euro area. Thus, reviving growth in Germany, tied to a durable reduction in euro area uncertainty, reflects our outlook for the remainder of this year and for next year. And Germany can play a leading role in reducing this uncertainty.

To provide a little bit of background, financial stress in the euro area has abated this year, in part due to the 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. As our staff report elaborates, measures of policy uncertainty remain elevated, but this is also corroborated by surveys at the firm level in Germany. This sensitivity of Germany 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 enterprises, the SME sector in Germany, despite easy financing conditions.

Looking ahead, economic activity in Germany is expected to be below potential in 2013 this year. We do see a gradual pickup in activity towards the end of the year, conditional on a further intangible reduction in the uncertainty I refer to and the gradual recovery in the rest of the euro area. This is what drives our 0.3 percent projection of growth for the year as a whole before picking up to growth at around the economy’s potential in 2014.

This baseline outlook is associated with a number of risks. 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 reemergence of financial stress in Europe which could interact with already weak demand and uncertainty to amplify the impact on the Germany 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.

Turning to policies, in the current global environment, the modest loosening of the fiscal stance in Germany this year is appropriate. Germany has already achieved its 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’ll be important to avoid over-performing on consolidation as has been the tendency in recent years.

Other key near-term priorities include further strengthening the banking system. While the overall soundness of the banking system 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, is also a priority. 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 center supervisory authorities. At the super national level, helping articulate a clear, harmonized, and coherent roadmap towards achieving domestic and European financial sector initiatives would help alleviate a major question mark over the European financial system.

Let me briefly highlight Germany’s role as an anchor of regional stability. First, 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. Its low borrowing costs also translate into lower overall yields for the rest of the region. Germany also plays a pivotal role in the development of policies and the evolving architecture of the European monetary union. 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.

Finally, let me briefly discuss reforms towards potential growth in Germany. Given demographic pressures, efforts to support the economy’s growth potential need to be sustained. Recent initiatives to counteract the decline in the labor force that is foreseen in coming decades are welcome, but further steps towards lowering the tax burden, increasing the availability of child care, and facilitating immigration, 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. More generally, a vibrant services sector would provide an additional engine of growth for the German economy, reducing its vulnerability to external shocks, improving its resilience and contributing to strong, sustained, and balanced global growth.

With those remarks, I will now be happy to take questions from you.

QUESTIONER: Hi, Mr. Lall, good afternoon. I would like to ask you two questions. One is what contribution do you think, regarding this anchor that Germany should be in Europe, what contribution do you think that Germany, Germany’s public and private sectors can give to the rebalances within the Euro zone, this north versus the south on one hand? And on the other hand, what is your evaluation at this point of the soundness of Germany’s banking sector?

MR. LALL: Thank you very much for your question.

First, regarding imbalances. If you look at our report, the most striking fact, as far as Germany goes, has been the weak investment that we have seen since the beginning of 2012, and that, to a large sense, explains some of the dynamics of the current account. Now, we expect -- and it’s one of the main themes of the report -- that as uncertainty about the euro area is alleviated, that will help increase investment and should obviously have an effect in reducing imbalances within the euro area. This imbalance, therefore, is a result not just of policies or even fundamentals in Germany, but an interaction of many different factors, both domestic and external. So as a result of that we think that part of this has been cyclical and should recover, and that’s what our baseline forecast is built around.

Now, on the public sector, we see some modest loosening of the fiscal stamp this year and, as I highlighted in my comments earlier, we think that is appropriate to support domestic demand in Germany. And so we are very much hoping that that will be supportive of demand more broadly.

Coming to the banking system, I would direct you to the report. The German banking system has strengthened considerably over the past few years and even comparing with our assessment last year we’re very encouraged by developments since then. The reliance on wholesale financing has, for example, been reduced. Capital has improved and there has been quite significant reform in the Landesbanken sector as well and shedding of risk assets and improving the capital. So, overall, financial stability has improved.

That being said, financial stability is always and everywhere an ongoing exercise, so we also in our report encourage that the process should continue. And I mentioned that there are some vulnerabilities related to, for instance, the shipping sector in some cases and international commercial real estate. So obviously, one needs to be mindful. But more generally, the progress in the financial sector has been very encouraging and our assessment in that regard is that the financial system is stronger than it was even a year ago.

QUESTIONER: May I ask you about wages? Should their growth increase in Germany? Do you have anything about having wages grow more in the north compared to the south in order to try to rebalance?

MR. LALL: Well, wages in the last couple of years have been increasing at a healthy pace and in line with productivity. They increased by about 3.4 percent in 2012. And, of course, as you know, the wage-setting process is a collective bargaining between employers and employees and not something that really is set by the federal government. Given that, but given the labor markets which are very healthy and unemployment is, you know, at post-reunification lows, we are very encouraged by wage developments and we think that there is scope for continuing healthy wage developments. And this will obviously be helpful in stimulating domestic demand.

It’s also interesting to note that if you look at the growth of consumption in Germany, and if you look at the last 10-year average and look at the developments in the last couple of years, they’re above the long-term average and that’s also a very encouraging sign. This reflects, as I mentioned, the condition of the labor markets, incomes increasing, employment -- the economy being at full employment level. So that’s certainly very helpful in terms of overall domestic demand.

QUESTIONER: What is your message to the incoming government? Because we have got elections at the end of September….

MR. LALL: Well, all our policy messages are in the report that you have with you and, I would encourage you to take a look at it. Obviously, that message remains our view and our policy advice valid for the next year or so or even longer, so, it really is consistent with whoever shall be in the government not just in Germany, but in general. Our staff report has policy advice going forward for the next year.

MS. ADAM: Could you maybe elaborate a bit on the leadership you were talking about?

MR. LALL: Yes. The way we look at it, to some extent, is we have policy uncertainty in the euro area. And clearly, as the largest economy in Europe, Germany plays an important role in shaping the debate and it has been playing a leadership role already. More specifically, for example, in the steps towards the banking union, all the different steps that need to be in place to get to that point -- and it’s an ongoing debate. It’s obviously a very detailed debate on many aspects of this. And our overall view is that the momentum towards the banking union, for instance, has to be maintained and Germany can help in articulating a clear, harmonized, and coherent roadmap towards achieving their European objectives. That could help reduce uncertainty and also articulate the shared vision for close economic and financial integration.

One of the things that we saw in our interactions in Germany, for instance, in the private sector, a lot of questions that would asked was, you know, the private sector would like to know what the landscape will look like, not just in the next six months, but over the next three, four, five years. And it is always helpful to reiterate this vision and that this vision is shared by all economies. Of course, more details and our specific advice are in our Euro Area Policies Staff Report, which was issued late in July. But our main view is that Germany is clearly a very important participant in the European debate and the most immediate priority right now is to move towards a banking union and to help reverse the fragmentation of European financial systems. Thank you.

QUESTIONER: Good morning. Also on the election I’d be curious to know whether you think the election that’s still more than a month away has had any impact on growth this year so far and whether the fact that the next government will presumably be in for four years will affect growth next year.

MR. LALL: Thanks for the question. Our assessment is that it’s really euro area uncertainty that’s affecting investment decisions in Germany. And, in fact, if you look at the German households, they seem relatively unaffected, as I just mentioned, you know, the discussion on consumption and wages, for example. So it’s really the corporate sector we’re talking about.

And based on our aggregate data, but on survey data as well as our extensive conversations, it’s really euro area uncertainty rather than domestic election-related issues that are driving both developments in the recent past as well as expectations for the near future. And so our forecasts are built around that. I think it would be premature to speculate on what might or might not happen after the elections because our main thesis is that it’s really euro area uncertainty that’s driving German dynamics.

QUESTIONER: Yes, hello. In the report you say that if Germany’s growth slows down below the target set for this year, Berlin should recalibrate its policies. Could you expand on that somewhat? Does this mean basically more stimulus spending, less fiscal consolidation, and could you add a little bit of detail? Thank you very much.

MR. LALL: Yes, sure, that’s a very good question. It’s really more about next year. We have a projection of growth for 1.3 percent, which would be in line with potential. If we see information coming in during the course, if we see second quarter growth this year and third quarter growth, and it points to a significant downward revision of our projections for next year, that would create the opportunity to have a rethink on fiscal policy and the recalibration that we refer to in the reports. It’s really about 2014, not 2013. And indeed, what that would mean is to think again about the authority’s fiscal plans and whether additional domestic demand support needs to be provided. So in the baseline we think that the plans are appropriate.

But, of course, if we were to revise down significantly growth for next year and the severity of that, then one would need to rethink the fiscal policy plans for next year. And certainly, we have a very modest consolidation built into our projections for next year and then that would certainly not apply anymore if growth were to remain very weak next year.

MR. SILVESTRE: Well, if we don’t have any more questions, this concludes our conference call on Germany. I want to thank all the participants for being here. Let me remind you that there will be a transcript of this call in a couple of hours and that you also will be in the position to listen again following the details that you got in the advisory. You’re going to be able to listen to this call again for another 24 hours. Thank you again.


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