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Germany: 2010 Article IV Consultation Concluding Statement of the IMF Mission
February 8, 2010
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
1. Strong policy support helped Germany emerge from the deep recession. After a sharp fall in the first half of 2009, the government’s globally-coordinated policy measures were crucial to the resumption of growth in the second half. Financial sector measures mitigated systemic stress and supported credit. Automatic stabilizers and significant fiscal stimulus contained the downswing and supported the recovery. And the surprisingly strong German labor market reflected flexibility gains from past labor market reforms, together with the expansion of the Kurzarbeit program.
2. But the recovery is likely to be moderate, with predominantly downside risks. Following a sharp decline of about 5 percent in 2009, we project GDP to grow by 1.5 percent in 2010 and 1.9 in 2011. Muted euro area expansion and the restraint of U.S. consumers will limit Germany’s export growth despite a still comfortable competitiveness position. Domestically, the boost from the cash-for-clunkers program (“Umweltprämie”) is reversing, consumers will remain cautious given the expected increase in unemployment and moderate income gains, and remaining banking problems will contain credit supply. Despite the damage to potential growth (owing to dislocation from the crisis), a sizable output gap will remain for the next several years. GDP growth could also be lower because of setbacks to world trade or the domestic financial system (such as a credit crunch, or spillovers from emerging and Southern European markets). Such setbacks could have self-enforcing effects, with additional pressures on unemployment.
3. Thus, the German authorities face the challenge of managing ongoing risks while preparing to unwind the extraordinary measures introduced during the crisis. Fiscal policy will have to transition from supporting the recovery to credible consolidation once private-sector growth becomes self sustaining. In the financial sector, the repair of balance sheets and restructuring must continue, but the time has also come for more permanent improvements to the stability framework in concert with ongoing EU initiatives. And extraordinary labor market policies need to be phased out and structural reforms undertaken to raise longer-term growth and domestic sources of demand.
Fiscal policy—consolidation will have to start once the recovery is firm
4. Fiscal consolidation needs to start as soon as the recovery has firmed up—which is projected for 2011. The 2010 budget appropriately provides stimulus for a still fragile recovery. As a consequence, the general government deficit is estimated to rise in 2010 to 5½ percent of GDP, nearly twice the target set by the European Union’s Stability and Growth Pact (SGP). With public debt on a rising path, contingent liabilities associated with financial support measures, and private sector growth expected to become self sustaining by 2011, fiscal consolidation should become a priority.
5. Germany’s commitment to the SGP and its new constitutional rule (“Schuldenbremse”) is welcome—and has potential benefits for Europe. The SGP requires lowering the general government deficit to 3 percent of GDP by 2013, and the constitutional rule mandates a close-to-balanced structural budget at the federal level by 2016. Meeting these targets would allow Germany to regain the fiscal space lost to the crisis and prepare for the rising costs of its aging population. Moreover, Germany’s actions also matter for Europe because, as in the past, German consolidation could set an example for other countries. This would help avoid an undesirable policy mix of tight monetary and loose fiscal policy in the euro area, with positive feedback effects on the German economy. Conversely, a failure to consolidate the public finances in Germany could greatly damage both the European and the national fiscal frameworks.
6. Meeting the consolidation targets is a formidable task.
• To fulfill the SGP target, the general government deficit—the combined deficit of the local, Länder, and federal governments, including the social security system—will have to decline annually on average by close to 1 percent of GDP in 2011-13. While the economic recovery and the withdrawal of the stimulus measures will contribute to meeting the target, the required adjustment is large by historic standards.
• To comply with the constitutional fiscal rule, the required annual structural adjustment of the federal government—which we estimate at ½ percent of GDP in 2011-16—will also be demanding. From an accounting perspective, the consolidation will be helped by the government’s decision to support the federal employment agency in 2010 through a one-time grant, instead of a loan. However, this measure provides no lasting consolidation in the absence of an increase in the unemployment insurance contribution rate to a sustainable level.
7. A credible plan—focused on expenditures—is needed, and quickly. Experience suggests that expenditure cuts are needed for lasting fiscal consolidation. While progress has been made in reducing subsidies along the lines of the Koch-Steinbrück initiative, a further systematic examination of subsidies (for example, in agriculture or mining) can yield budgetary savings. It will also be crucial to strictly adhere to the agreed-upon adjustment mechanisms for pension benefits and the gradual rise in the retirement age. Realizing potential savings in the health care system (for example, by limiting spending on non-generic pharmaceuticals) would also help.
8. Revenue measures might have to be part of the solution. The first priority would be to broaden the tax base of the income and VAT taxes by eliminating exemptions, including those recently introduced. If tax rate increases were unavoidable, higher VAT rates would prop up revenues at the federal and Länder levels, and a reform of the property tax could support local finances. Also, an increase of contribution rates to the unemployment insurance would remove the need for repeated federal government support.
9. In this context, tensions in the fiscal plans for 2011 need to be resolved. The permanent tax cut of about 1 percent of GDP included in the coalition agreement would kick in just when the recovery is expected to firm up. This would counter the required consolidation effort, while promising only modest efficiency gains. Any tax measure should be designed to maximize efficiency and be implemented only with compensating budgetary measures, preferably on the expenditure side.
Financial sector—keeping the momentum of restructuring and reform is crucial
10. The health of the financial sector has improved, but time is running short for dealing with the remaining problems and risks. The steepening yield curve, the improving economic outlook, and the authorities’ financial sector measures have benefited banks. Some of Germany’s larger banks have deleveraged their balance sheets and added to their capital. Still, according to Bundesbank estimates sizable write-downs remain. These along with risks to the recovery and banks’ exposure to emerging and Southern European markets create vulnerabilities. With the expected tightening of euro area liquidity, the window for resolving remaining financial sector problems is closing fast. The sunset clauses for new public support through the Sonderfonds Finanzmarktstabilisierung (SoFFin) by end-2010 add to the urgency. Strengthening capital buffers should be a priority for most banks. Enhanced surveillance of the German banking sector would profit from more comprehensive and timely data and transparent reporting.
11. This is the moment to deal head on with the ailing Landesbanken sector. The crisis shed a glaring light on the systemic risks posed by this sector. The risks arise from the structural unprofitability of many Landesbanken: their high cost structure and lack of a proper business model has caused excessive risk taking in search of profits. The Landesbanken have been a drain on public finances, requiring capital infusions from the Länder. Despite initial steps towards restructuring, much more needs to be done to prevent the Landesbanken from being a continuous source of financial instability for Germany. Major consolidation of the Landesbanken—possibly into one wholesale bank for Sparkassen—is a priority. Any remaining institutions should have effective governance and viable business models, with an alternative ownership structure.
12. The Government’s welcome commitment to make the Bundesbank the sole prudential bank supervisor should enhance accountability and speed up enforcement. While the reform can be implemented using a variety of organizational models, any new arrangement should be designed to ensure the incentives and capability to identify and address systemic risks. To this end:
• One national agency must have a clear mandate for macroprudential oversight and monitoring systemic risk. The Bundesbank is the natural choice in this regard, given its experience in banking supervision and financial stability analysis. Placing prudential supervision over the entire financial sector—in particular banking and insurance given their interconnectedness in Germany—under the Bundesbank would facilitate both this process and the Bundesbank’s ability to represent Germany on the proposed European Systemic Risk Board. The Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) would then become the market conduct supervisor, with responsibility for securities firms and markets and consumer protection for the entire financial sector.
• Regardless of the responsibilities given to the Bundesbank, the resulting body should be both accountable and operationally independent to deliver effective supervision.
• The transition risks need to be managed to avoid supervisory lapses. The merger and reorganization could well distract staff from their primary mission. Therefore, it is critical to clarify early the form of the final reorganization and prepare for speedy implementation by early 2011.
13. The global financial crisis has reinforced the need for countries to have strong and effective regimes for bank resolution. Building on the temporary measures taken with the creation of SoFFin, the authorities have begun to develop a legal framework for resolving systemically important banks in an orderly fashion. As discussed at the European level, this framework should allow for bridge banks and transactions involving the assumption of liabilities and the purchase of assets. Moreover, a special regime to allow for the orderly exit of non-systemic banks is also needed to avoid the current recourse to slow and disruptive corporate insolvency procedures. A permanent bank resolution regime should be in place by early 2011, given the sunset provisions for SoFFin. In case of a delay, SoFFin’s powers should be extended.
14. The long-standing limitations of the German deposit insurance regime were exposed by the recent crisis, and the regime should be strengthened in light of evolving EU initiatives. The association-sponsored deposit protection schemes rely largely on after-the-fact contributions from members at the time of stress, which can exacerbate a crisis. The high coverage offered can be difficult to maintain without public support—a point illustrated by the help provided by SoFFin for the commercial banks’ deposit protection scheme. With the further increase of deposit insurance coverage to €100,000 next year, consideration should be given to creating a unified fund for deposit insurance spanning the entire banking system.
Structural policies—fostering adjustment
15. Extraordinary support should be withdrawn also in the structural area. Short-term crisis policies in the labor market and state aid have helped to preserve employment during the downturn, but they could become impediments to long-run growth if continued well into the recovery. The government’s intention to adjust the conditions of the Kurzarbeit scheme to the pace of the recovery is therefore welcome.
16. Additional reforms can help Germany’s adjustment to the post-crisis world. Reduced potential growth and the threat of lower export demand raise the importance of further improving the flexibility of domestic markets. Lower legal and labor-court-based employment protection would facilitate reallocation of workers, while simultaneously tackling remaining obstacles to product market competition (under consideration by the government) and to service sector development would foster labor demand. These reforms, through strengthening domestic sources of growth, would not only benefit Germany but could also help rebalance euro area and global trade.
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