Germany: Staff Concluding Statement of the 2023 Article IV Mission

IMF News, May 16, 2023

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Published: May 16, 2023

Mission overview

Mission led by Kevin Fletcher, comprising Ting Lan, Aiko Mineshima, Galen Sher, and Jing Zhou.
Mission dates: May 2‒16, 2023. Statement issued: May 16, 2023.
Key near-term policy priority: support disinflation with a moderate tightening of the fiscal stance in 2023 and supply-side reforms, while monitoring financial stability risks arising from rapidly rising interest rates and global financial market turbulence.
Long-run challenges identified: population aging, the need to combat climate change, and heightened risks of geo-economic fragmentation.

Recent economic developments and outlook

Resilience: Germany weathered the fallout from the Russian gas shut off well, reflecting a mild winter and strong policy responses.
Near-term headwinds: tighter financial conditions and the energy price shock are expected to keep economic growth muted.
Growth outlook:
- GDP growth expected to stay near zero in 2023.
- GDP growth expected to gradually strengthen to 1-2 percent during 2024-26.
- Over the longer term, average GDP growth expected to fall back below 1 percent absent significant accelerations in productivity and/or labor supply growth.
Inflation outlook:
- Headline HICP inflation: 7.6 percent in April; expected to fall to around 4½ percent by late 2023.
- Core inflation: expected to decline later and more slowly; risks from nominal wage pressures and lagged pass-through from declining commodity prices.
Uncertainty and risks:
- Baseline risks tilted downward.
- Downside risks: persistent core inflation requiring tighter monetary policy; renewed global banking turbulence increasing funding costs and tightening financial conditions.
- Upside risks: faster unwinding of supply disruptions and stronger external demand.

Fiscal policy

2023 stance:
- Fiscal stance should be moderately tight in 2023 to support disinflation.
- Spending on gas and electricity brakes likely lower than budgeted in 2023; fiscal revenue may overperform. If windfalls are saved, cyclically-adjusted primary balance expected to turn moderately contractionary in 2023.
- Further fiscal contraction warranted in 2024 under the baseline scenario.
Energy relief measures:
- Gas and electricity price brakes maintain incentives to conserve energy and many relief measures are income-taxable and progressive.
- Recommendation to improve targeting: consider temporary solidarity taxes on higher-income households or greater claw-back of energy price relief provided to them.
- Recommendation that gas and electricity price brakes be allowed to expire as planned by April 2024 at the latest.
Medium-term fiscal room:
- Mission expects Germany’s fiscal deficit to narrow to around ½ percent of GDP by 2027 as energy-relief measures phase out and the economy recovers.
- Constitutional debt-brake rule limits annual new structural borrowing to 0.35 percent of GDP at the federal level.
- Assessment against an overall deficit of around 1¾ percent of GDP would stabilize debt at around 60 percent of GDP.
- Envisaged increases in aging-related and defense spending leave little scope for higher public investment without creating new fiscal room.
- Options to create fiscal room: expenditure reforms, mobilizing additional revenue, and/or adjusting the debt brake rule; examples include reforming property taxes and reducing distortionary or environmentally harmful subsidies.
Debt-brake rule and extrabudgetary funds:
- Germany created extrabudgetary funds totaling about 9 percent of GDP (Climate and Transformation Fund, Special Defense Fund, and “Protective Shield”).
- Spending from these funds does not count against the debt-brake limit but does count toward the general government deficit under EU standards, weakening the link between the debt-brake and debt dynamics.
- Recommendation: consider revising the rule to limit use of extrabudgetary funds and increase somewhat the annual deficit limit, perhaps by 1 percentage point of GDP, while awaiting the conclusion of the EU’s review of its fiscal rules.
Public investment implementation:
- Welcome efforts to accelerate public investment, including alleviating local staff shortages by using external project managers and reforming public procurement to simplify and digitize procedures.

Financial sector policies

System resilience:
- Aggregate capital and liquidity levels remained substantial at end-2022 despite mark-to-market losses in 2022.
- Bank capital: 19.2 percent of risk-weighted assets at end-2022.
- Liquidity coverage ratios: 154 percent for significant institutions and 178 percent for less-significant institutions.
- Substantial deposit insurance coverage supports funding stability; insurers’ solvency positions were well hedged despite mark-to-market losses.
Monitoring and supervisory actions:
- Rapidly rising interest rates raise financial stability risks; authorities should identify banks most vulnerable to interest-rate and liquidity stress and subject them to intensive supervision.
- Supervisors should encourage a conservative approach to bank capital distributions.
- Enhance transparency around bank health (publish additional risk analyses, disclose more information on LSIs, clarify public safety nets).
- Enhance data collection and stress tests of interest-rate risks at LSIs.
- Encourage investment funds to adopt liquidity management tools (gates and notice periods).
Safety nets and resolution:
- Consider simplifying depositor protection by moving to a single mandatory scheme with a robust public liquidity backstop.
- Resolution plans should account for potential joint resolution of several members of an institutional protection scheme (IPS) and joint resolution of an IPS member with an IPS itself.
- Completion of the pan-European Banking Union and Capital Markets Union would enhance stability and efficiency.
Real-estate sector measures:
- Rising vulnerabilities in the real-estate market over the last decade; partial correction of house prices began in late-2022 from overvalued levels.
- Welcome higher capital requirements that took effect in February 2023.
- Recommend modifying the law on borrower-based measures to remove obstacles to early activation and add income-based instruments.
- Welcome collection, starting in 2023, of more robust data on lending standards in residential real estate.
- For commercial real estate, facilitate harmonization of lending-standard definitions and collect/publish comparable data on LTV ratios, interest- and debt-service-coverage ratios, and debt-yield ratios.

Structural reforms

Green transition:
- Germany met its 2022 CO2 emission target due to a sharp decline in industry emissions and favorable weather.
- Recommendation to resume the increase in domestic carbon pricing in 2024 as planned and consider further strengthening it.
- Enhance take-up of existing programs by simplifying procedures and ensuring cohesion across programs.
- Limit additional subsidies to addressing market failures and ensure fiscal affordability across EU countries.
- Accelerate expansion of EV charging stations and the smart grid network; consider revenue-neutral feebate schemes.
- Support for the EU Carbon Border Adjustment Mechanism and Germany’s leadership in creating the Climate Club.
Human capital and labor supply:
- Plans to augment the Skilled Immigration Act should help dampen the projected decline in the labor force due to population aging.
- The recently passed Bürgergeld includes training initiatives to help the unemployed find better-paying jobs; monitor and adjust Bürgergeld design to avoid lengthening unemployment spells.
Productivity and innovation:
- Germany is an innovation leader in Europe but labor productivity growth has declined over the last decade and trails non-European advanced economies.
- Low labor productivity growth driven mainly by lower ICT capital deepening and weaker multifactor productivity; new business registrations have trended downward.
- Recommendations to lift productivity:
- Enhance incentives for R&D, including expanding R&D tax credits and increasing availability of qualified workers.
- Expand funding for young and innovative firms by reducing barriers to institutional investors in venture capital and aligning tax treatment of stock-ownership option plans with international standards.
- Lower market entry barriers by increasing digital government, reducing administrative red tape, and strengthening the competition framework.
Geo-economic fragmentation (GEF) preparedness:
- Intensified geopolitical tensions raise GEF-related risks that could increase output losses and financial instability.
- Recommendations:
- Support a multilateral, rules-based trading system.
- Identify critical dependencies, assess impacts and transmission channels of GEF scenarios (e.g., stress tests of value chains), and develop coping strategies.
- Pursue structural reforms to retain Germany’s attractiveness as an investment destination.

Closing remarks

The mission thanks the authorities and counterparts for their hospitality and constructive dialogue.

IMF mission, led by Kevin Fletcher, conducted discussions for the 2023 Article IV Consultation with Germany during May 2‒16 and issued this Staff Concluding Statement on May 16, 2023.