Euro Area—IMF Staff Concluding Statement of the 2019 Article IV Mission
IMF News, June 13, 2019
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- Published: June 13, 2019
Overview
- The euro area is at a challenging juncture. Growth is expected to firm-up later this year but there are significant risks to this outlook.
- Greater structural reform efforts at the national level would enhance the region’s resilience.
- In the event of a sharp downturn additional policy support will be needed.
- While there is some progress on euro area reforms, in many cases political consensus on the path forward is missing.
- The incoming European Parliament and European Commission should use the opportunity to forge a renewed consensus around strengthening the foundations of the monetary union.
Outlook and Risks
- Growth has slowed and inflation continues to disappoint.
- Growth decelerated sharply in the second half of 2018 due to slowing external demand and mostly temporary domestic factors.
- Headline inflation has fluctuated with energy prices; core inflation has remained troublingly low despite declining unemployment and a gradual pickup in wage growth.
- Growth should firm up over the course of this year, premised on:
- continued robust domestic demand on the back of a tight labor market,
- a global recovery, and
- continued monetary accommodation.
- Inflation is forecast to reach the ECB’s objective only gradually, reflecting subdued core inflation.
- Little progress has been made on reducing imbalances: the euro area current account surplus has narrowed slightly, but is still assessed by IMF staff to be moderately stronger than warranted by fundamentals, primarily driven by a few countries with sizable current account surpluses.
- Three serious risks could derail the upswing:
- Prolonged global trade tensions undermining external demand.
- The risk of a no-deal Brexit remains high; the financial sector has made progress preparing, but firms in other sectors—especially smaller firms—are less prepared.
- High-debt countries’ failure to rebuild fiscal buffers and implement structural reforms, leaving them vulnerable to shifts in market sentiment and the next downturn.
- These risks could materialize synchronously; even without a major shock, the euro area could experience a prolonged period of anemic growth and inflation.
Monetary and Fiscal Policy
- Persistent undershooting of the inflation objective calls for prolonged monetary accommodation, though this carries risks.
- The ECB’s stance is already accommodative; recent further extension of its forward guidance should support a sustained pickup in inflation.
- Risks of prolonged low rates:
- Heterogeneity in cyclical conditions across countries could lead to financial stability risks in countries with positive output gaps.
- Macroprudential policy tools should be actively deployed to contain these risks.
- If the inflation outlook is downgraded further, even greater accommodation will be needed.
- Fiscal rule compliance and enforcement need improvement now:
- Despite robust growth in recent years, high-debt countries have not sufficiently consolidated and in some cases have eased fiscal policy.
- Lenient enforcement has weakened incentives to respect the rules and made it hard for EU institutions to credibly react to new violations.
- Policy guidance by fiscal space:
- Countries with limited fiscal space should prioritize debt sustainability.
- Countries with ample fiscal space should use it to lift potential growth, taking advantage of low borrowing costs to invest in infrastructure, innovation and education.
- If growth deteriorates sharply:
- The escape clause in the fiscal framework could be activated to allow fiscal support, differentiated according to national fiscal space, financing conditions, and downturn severity.
- Fiscal policy should become more expansionary through temporary, high-quality measures in countries with fiscal space.
- Fiscal consolidation could be slowed temporarily in countries where fiscal space is at risk, provided financing conditions remain amenable and debt sustainability is not jeopardized.
Structural Reforms
- Deeper productivity and competitiveness problems in some countries require decisive structural reforms; more demand will not fix these problems.
- Product and labor market reforms are critical to closing productivity and competitiveness gaps and would most benefit countries with lower productivity levels.
- Reforms would make economies more resilient, lessening the depth and duration of downturns.
- The new Commission should reinvigorate the push to fully implement the EU Services Directive:
- The single market for services lags far behind the single market for goods.
- Better implementation has the potential to boost productivity and cross-border trade in services through country-specific recommendations and stepped-up enforcement.
- The next EU budget provides an opportunity to provide more financial and technical support for reforms.
- The EU has been proactive in safeguarding gains from international trade and the IMF welcomes the EU’s initiatives to reform the World Trade Organization.
Financial Sector
- Strengthening the banking sector is critical to resilience:
- Banks have boosted capital buffers and made progress on reducing nonperforming loans, but low bank profitability remains pervasive.
- Supervisors should continue to assess banks’ business models, pushing for greater revenue diversification and cost efficiency, including through cross-border mergers and acquisitions.
- Progress on 2018 FSAP recommendations:
- The Single Supervisory Mechanism (SSM) is monitoring liquidity more closely and has begun using early intervention powers.
- Reviews of bank supervision and resolution frameworks have been delayed until the next Commission, but the SSM has begun developing an action plan to reduce legal fragmentation in supervision.
- The new Commission should use the reviews to reduce legal fragmentation and enhance supervisory and resolution toolkits as recommended by the FSAP.
- Anti-money laundering (AML) needs centralization:
- Recent money laundering cases highlight fragmentation.
- The SSM’s new AML coordination function is welcome as a central point of contact and information exchange for systemic institutions.
- Over the medium term, an EU-level AML body should be established, consistent with FSAP advice.
Euro Area Architecture
- A truly borderless banking market requires more ambitious steps:
- Agreement on the European Stability Mechanism providing a backstop to the Single Resolution Fund is welcome, but the final design must allow rapid deployment in a crisis.
- Ring fencing of capital and liquidity at the national level impairs banking union development and reflects home–host tensions on burden-sharing when banks fail.
- Addressing this will require creating a common deposit insurance scheme with due attention to risk reduction; the next Commission should seek to reenergize this effort.
- The next Commission should push to develop the Capital Markets Union (CMU):
- Capital markets in Europe remain fragmented, impeding cross-border private sector risk sharing.
- Technical actions to advance the CMU include centralized reporting requirements for companies, minimum standards on insolvency regimes, and simplified procedures for reclaiming withholding taxes.
- A euro area-level macroeconomic stabilization instrument is needed:
- A central fiscal capacity could enhance resilience to shocks.
- Agreement on such an instrument is likely to take time.
- The proposed euro area Budget Instrument for Convergence and Competitiveness is an encouraging acknowledgment of the need for a euro area-level fiscal instrument, though details have not been determined.
- Fiscal rule simplification:
- A simplification would make rules easier to communicate, monitor and enforce.
- IMF staff favor focusing on an expenditure growth rule anchored by a debt rule.
- Revamping the fiscal rules will be difficult, but the next Commission should engage the issue.
- Next EU budget considerations:
- Brexit will result in the loss of the U.K.’s net contribution to the EU budget for 2021–27.
- This could be tackled with a mix of new revenue sources and streamlining of some expenditures.
- The next budget should be reoriented to address priorities such as climate change, innovation, migration, and security.
- Strengthening architecture and addressing common challenges will require creative cooperation; governments should do more to reduce imbalances and increase economic resilience at the national level given imminent risks.
Source: Euro Area—IMF Staff Concluding Statement of the 2019 Article IV Mission (June 13, 2019)