Transcript

Washington, D.C.
Thursday, December 14, 2006

MS. MBOTO FOUDA: Good morning, everyone, and welcome to this conference call on the launch of the 2006 Article IV Consultation Report for Germany. I am Lucie Mboto Fouda from the External Relations Department of the IMF, and with me here today are Ajai Chopra, Deputy Director in the IMF's European Department, and Bob Traa, Division Chief in the same Department.

The report on the 2006 Article IV Consultation for Germany, as you may know was reviewed by the IMF's Executive Board on December 8, 2006. The staff report, the Public Information Notice summarizing the Board's discussion, as well as other supporting documents were posted on our password-protected Media Briefing Center yesterday and I hope you had a chance to cast a look over there.

Mr. Chopra will offer opening remarks, and both he and Bob will take questions. I will now turn the floor over to Ajai for his introductory remarks.

MR. CHOPRA: Thank you, Lucie. Ladies and gentlemen, welcome to this conference call on the Germany Article IV Consultation for 2006. Good morning to those of you in he U.S., and good afternoon for those participating from Europe. My name is Ajai Chopra and I am the Mission Chief for Germany. Bob Traa, the Division Chief for Germany is also present with me. I will start with some brief introductory remarks before inviting your questions.

First, on cyclical developments, our visit to Germany took place in September and the IMF Executive Board's discussion on our report took place last Friday. It is obvious that the Germany economy is doing much better in 2006 than we have seen some years. In fact, we have increased our growth forecast since we were in Berlin just a couple of months ago, and now believe that growth will be around 2-1/2 percent in 2006, followed by growth of about 1-1/2 percent in 2007. Growth was also more broadly based, although consumption growth is still quite tepid.

We expect that the increase in the VAT in January will have some influence on growth, but that this impact will be transitory. When thinking about the VAT increase, it is important to keep in mind that the unemployment insurance tax will be cut by 2.3 percentage points. Previously it was to be cut by 2 percentage points, and this cut takes place in January which will soften the impact of the VAT hike. We support this switching in taxes from direct taxes on wages to indirect taxes such as the VAT because this is a positive structural measure that will help limit labor costs and bolster employment in the long-run.

Inflation has dropped somewhat recently, led by lower oil prices, and has remained below 2 percent. We expect that inflation will pick up in the first months of 2007, again reflecting the VAT increase, and that the average inflation for 2007 will be about 2.3 percent. It should come down again in 2008, so we expect that the inflation impact will also be transitory.

Employment growth has been hardening in Germany this year and is one of the reasons why we believe that the upswing will be sustained into 2007. It is good news that after years of wage moderation, full-time jobs are now growing again. This is a good sign that the adjustment efforts and the labor market policies of recent years are beginning to have a positive effect on the economy.

I will now turn to fiscal issues. This is an area where the coalition government has been steadfast and deserves credit for preserving with substantial consolidation. It is sometimes remarked that the reduction in the deficit is only a sign of higher taxes, but this is not true in our view. Pensions and public-sector wages have been frozen for 2006-2007, and this is also delivering substantial adjustment. All of the VAT increase also delivers resources to bring down the deficit and, of course, the cyclical upswing is temporarily but substantially boosting corporate income tax revenues. We estimate that a significant part of the underlying or structural reduction in the deficit is coming from expenditure containment.

Beyond 2007, however, additional policies will need to be identified to continue on the path of fiscal consolidation in order to reach balance of the underlying or structural deficit by 2010. To achieve this goal, we continue to see scope for reducing spending on subsidies and tax expenditures and on active labor market programs that are ineffective in meeting their goals.

On fiscal reforms, the corporate income tax and health care reforms are appropriately high on the government's agenda, but these are also very difficult policy items. The Fund fully endorses the authorities' efforts to cut the high statutory corporate tax rates, the resulting losses to be offset in large part by base-broadening. The staff team was uncomfortable with the initial proposal made in July to reduce interest deductibility from taxable business income, but we are more comfortable with the recent proposal which is more specific to cases where there is evidence of tax shifting to subsidiaries abroad. We also support the normalization of depreciation charges which are unusually generous in Germany. And we urge the authorities to keep the net cost of the corporate income tax reform to 5 billion euros, which is a quarter-percent of GDP.

On health care reform, we believe that the proposals that are being considered right now are not sufficiently ambitious to reduce significantly the future cost pressures on the system. However, we do hope that competition in the health care system will be increased to deliver such results. We also recommend that health care financing be separated more from wage costs than is currently the case, because otherwise future payroll taxes may still need to be increased substantially.

Now turning to labor and product market reforms, the consultation this year discussed several important policies in these fields. As you know, the Fund's staff has argued against implementing minimum wages in Germany because we believe that this would interfere with bringing down reservation wages and hurt employment opportunities for the more vulnerable workers. We are also very cautious about wage subsidies which could become costly and introduce new distortions. However, we support the authorities' efforts to improve the ineffectiveness of the Hartz IV legislation, and in this context, we endorse the proposal by the Council of Economic Experts and also by several think tanks in Germany to cut benefits by 30 percent for those workers who are willing to accept work. On product market reforms, we see a need to improve effective competition in the electricity and other network industries, and to deregulate domestic markets more generally to create more competition for incumbents, including in crafts and services.

Now turning to the financial sector and capital markets, the German financial sector is doing better. Banks and other players have lowered costs, and they also benefiting from the stronger cycle. However, revenue generation is still weak, and the profitability of banks is lower than elsewhere in Europe. We see that Ländesbanken are making progress in developing new strategies, and the ownership structure of several Ländesbanks is changing. On our view, this process should extend beyond Ländesbanken to Sparkassen, and we continue to believe that more participation by the private sector could unlock efficiencies and better performance in the banking system. We support the authorities' efforts to make the capital market function better with clear rules and regulations. We welcome the creation of RIETs, that is Real Estate Investment Trusts. We hope that these could be opened up to residential properties as well because this is where there is a lot of potential to mobilize the market, including with sales of properties by municipalities, Länder, and also large corporations. In short, we believe that further capital market deepening together with a more dynamic banking system can facilitate the entry of new firms, spur innovation, and enhance corporate business, thereby contributing to growth.

In short, ladies and gentlemen, we see progress in Germany that has been underpinned by the private sector's sustained restructuring and wage moderation. The reduction in the fiscal deficit which represents not just cyclical factors but also underlying adjustments has also been impressive, and important reforms have been implemented to improve the functioning of labor markets and reduce the cost of entitlement programs. However, an underlying theme of the Executive Board's discussion last week was that despite this progress, and despite relatively bright cyclical prospects, there are still deep-seeded problems that need to be tackled to improve trend growth which remains low, to further lower unemployment which remains high, to ensure sustainability of the welfare state, given population aging, and to make the economy more resilient to shocks. So there is still plenty to do, and the cyclical upswing produces a conducive environment in which to push the agenda forward.

Let me stop here because the specifics of our policy recommendations which we see as being mutually reinforcing are spelled out in our report which is being placed on the Web site. Thank you, and I am happy to take your questions.

Questioner: Two questions. First of all, the Bundesbank Chief Axel Weber said yesterday that attacks by some French politicians on the independence of their European Central Bank were unacceptable and they are responsible. I would like to hear if you share his view.

The second question is, in your reports there are forecasts for the German economy to grow by 2.3 percent this year and 1.4 percent next year. I am wondering can we compare those to the forecasts from the World Economic Outlook in September? In other words, has there been an upward revision from the forecasts in September?

MR. CHOPRA: On your first question, I really have nothing to say. The only point that I want to make which I think is relevant for the German context is that there is often a question asked as to what should be the monetary response to the VAT increase, and I think that is the more relevant question. On this, as I have said, we expect the impact of the VAT increase on inflation to be temporary. We expect it to be short-lived. We do not expect that it will lead to second-round effects. And we do believe that the ECB has established quite a bit of credibility to counter these second-round effects, and leave it at that on that particular question.

On the question about the forecasts, I am glad you asked that because I think when we release these bundles which have a lot of different documents, it becomes a little bit confusing as to what are very latest forecast is. The staff report itself was written in early-November and was issued to our Board in early-November, and that had the particular numbers that you mentioned, a growth forecast of 2.3 percent in 2006, and a forecast of 1.4 percent in 2005.

If you see the package that has been released, in addition to the staff report, we issue very close to the Board meeting which took place on December 8, a small update, and this update is in the package and it is labeled "Statement by the Staff Representative on Germany." This statement gives a revised view, and in that statement we say very clearly that we have updated our forecast, and this is what was in my oral remarks earlier, saying that our latest forecast is now for growth of 2.5 percent in 2006, and 1.5 percent in 2007. These updates were done after the third-quarter GDP results were released. Time does not stand still, and so we have updated our forecasts, and we will continue to do so. For 2006, in fact, I see that there is potential that it could be somewhat even higher than 2.5 percent. I would not rule that out.

Questioner: When was the previous Article IV report on Germany? I don't remember how often you do these. Then also, were there any surprises in your latest review? Was there anything that you found that you did not expect?

MR. CHOPRA: We do these Article IV Consultations on an annual cycle, so there is typically a 12-month gap between these. This particular year the gap has been a little bit shorter. We last did a similar conference call on Germany in January 2006. In fact, that consultation had been delayed a little bit because of the formation of the Grand Coalition Government which moved us a little bit off the cycle. So the last one is on the Web and you can check it out. It was posted on the Web around the middle of January 2006, so it has been 11 months, essentially, since the last round.

What were the surprises? Let me put it this way. I have been working on Germany for the last 4 years, and we have been waiting for this recovery for a very long time. One of the big puzzles for us has been why has it taken so long for the external impulse to feed into domestic demand. We have a Selected Issues paper on this which is the part of the package that looks at the various explanations.

One very pleasant surprise for me was that after all this waiting, we are now beginning to see this change in the impulse away from only external demand to also domestic demand, especially investment, and also the construction sector I hope has finally bottomed-out after a decade-long slump.

A second aspect is the fiscal consolidation. I think when the Grand Coalition came in, their initial intention was to phase the fiscal consolidation with much more emphasis on 2007, and to give space for the economy to recover in 2006. In the event, what they did was that they actually achieved much more fiscal consolidation in 2006 than had been initially programmed, and they did this with very tough expenditure restraint. They did not raise taxes as such in 2006, but there was very tough expenditure restraint, so the fiscal consolidation has proceeded faster than what we had expected when we did this conference call in January. In that context, you might say given that we pressed very hard for them to be ambitious on the fiscal front, maybe it paid off. I do not want to take too much credit for it, but we were pressing for a more ambitious fiscal consolidation agenda, and I am very pleased to see that that was taking place this year. Of course, much more needs to be done after 2007, but I think full credit needs to give for 2006 and 2007 on the fiscal front.

The third thing, and this is the last thing that I will mention that I was very pleasantly surprised to see is that the restructuring in the Ländesbanken has proceeded faster than we had thought. We all knew that when the government guarantees were to expire, they are being phased out, we had called for a change in the business strategies of the Ländesbanken, and a number of these Ländesbanken have indeed changed their strategies. They are much more open to private capital and I think there is a change in the attitude toward public ownership of these Ländesbanken. There is of course a lot more that needs to be done, but that process has started, so we found a greater willingness to allow private capital in the Ländesbanken.

Actually, I do think I have a fourth one, if you permit me, and that is capital markets are becoming slowly much more vibrant in Germany, and this is changing corporate behavior. So let me stop there. I think that that is quite a list that I have given you.

Questioner: Just a technical issue again. You mentioned that in the package there is an updated report. I am guessing that is the Staff Report, Selected Issues item on Germany that I think was from November.

MR. CHOPRA: We will double-check that. It is a part of the package, I am quite sure it is. It is dated December 5, 2006, and it is titled "Statement by the Staff Representative." And I should also point out that there is a statement by the German authorities, from the German Executive Director, that should be a part of the package as well. To get the full picture, you should look at the Germany Executive Director's statement as well as the staff statement.

MS. MBOTO FOUDA: If we are showing no further questions, maybe should we conclude this conference call here. I would like to remind participants that the embargo will be lifted at 9:30 a.m. Washington time as initially indicated. This include this conference call and the material posted on the media Briefing Center yesterday. Thank you.