Germany: Staff Concluding Statement of the 2019 Article IV Mission
IMF News, May 17, 2019
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- Published: May 17, 2019
Overview and context
- Germany’s economic fundamentals are sound: public and private balance sheets healthy, unemployment at a historical low, wages accelerating, and the large current account surplus slowly shrinking.
- Short-term shock in H2 2018: Real GDP growth slowed sharply due to weak external demand and special factors (slow rollout of new emission tests for cars), underscoring vulnerability to external shocks (trade tensions, China slowdown, disorderly Brexit, renewed euro-area stress).
- Long-term challenges: aging population, weakening productivity growth, slow energy transition progress, uneven distribution of gains (lower incomes stagnant, increased corporate savings in family-owned firms).
- Key historical and recent numeric points:
- Current account surplus peak: 8.5 percent of GDP in 2015.
- Current account surplus in 2018: 7.3 percent of GDP.
- Fiscal surplus last year: 1.7 percent of GDP (largest since reunification).
- Fiber optic broadband: 2.5 percent of broadband connections.
- Venture capital investment as a share of GDP: 60 percent of the EU average in 2017.
Core policy recommendations (summarized)
- Fiscal policy
- Continue to use space within fiscal rules to bolster long-term growth and help rebalance the economy.
- Priorities:
- Lower the burden of taxation on low-income households.
- Reduce disincentives to work for secondary earners.
- Expand Research & Development credits for companies.
- Continue investment in public infrastructure.
- Structural and regulatory
- Upgrade digital infrastructure and implement the “National E-Government Strategy” rapidly to reduce bureaucratic burdens.
- Reduce uncertainty related to the energy transition and adopt a clearer strategy to curb greenhouse gas emissions (include public transport, sustainable mobility, concrete plans to phase out coal-fired power production by 2038, and consider a carbon tax).
- Strengthen support for start-ups and scale-up activity (attract institutional investors, encourage cross-border investment in the EU Capital Markets Union).
- Financial sector
- Encourage banking sector restructuring (consolidation, cost-cutting, develop fee-based income) to bolster profitability and reduce risks.
- Accelerate life insurance sector adjustment away from conventional guaranteed-return products.
- Activate macroprudential instruments to enhance banking resilience and guard against real estate imbalances.
- Urgently address data gaps to enable fuller assessment of financial stability risks.
Context and key challenges (detailed findings)
- Labor market and wages
- Sharp decline in structural unemployment over the last decade.
- Wage growth lagged initially, contributing to stagnation of lower incomes; more recently wage growth picked up with tight labor market and national minimum wage introduction in 2015.
- Faster wage growth is important to support external rebalancing via real exchange rate appreciation and broader sharing of growth benefits.
- Demographics and productivity
- Rapid population aging and reported labor shortages are widespread.
- New immigration law aims to attract skilled labor from outside the EU.
- Margins to expand labor supply via older workers, mothers, and refugees exist but aging labor force expected to decline in the medium run.
- Labor productivity growth has declined over two decades, including manufacturing, reflecting limited capital deepening.
- Digital and innovation gaps
- Limited high-speed internet coverage: fiber optic only 2.5 percent of broadband connections, more than 20 percentage points below OECD average.
- Venture capital investment = 60 percent of EU average (2017), constraining scale-up of startups.
Fiscal policy (findings and recommendations)
- 2019 fiscal stance
- 2019 budget is expansionary: increase in family support, more public investment (public investment grew by almost 8 percent in nominal terms in 2018), income tax relief through higher basic tax allowance and correction of bracket creep.
- Fiscal expansion measures amount to around 2/3 of a percent of GDP.
- Medium-term guidance
- Remaining space under fiscal rules should be used from 2020 onwards to strengthen growth potential by promoting innovation, expanding labor supply, and filling infrastructure gaps.
- Tax and investment policy recommendations
- Further tax relief for low-income households to boost disposable income and consumption.
- Reduce high effective marginal tax rate for secondary earners to increase female labor force participation; expand childcare and after-school programs.
- Consider creating room for such measures by reforming property and inheritance taxes.
- Expand the government’s R&D tax credit envelope to incentivize targeted business investment.
- Maintain leadership on anti-tax avoidance measures and preserve a competitive corporate tax system; assess adjustments to provisions (notably controlled foreign corporations) and further develop modalities of the proposed minimum tax by Germany and France.
Education, labor supply, and infrastructure
- Education and skills
- Raise investment in education and life-long learning; urgent need to address teacher shortages in vocational education, training, and primary education.
- Ensure the education system equips workers to adapt to rapid technological change.
- Continue refugee integration efforts: German language proficiency, labor market experience, and transferability of selected qualifications.
- Infrastructure and local government capacity
- Continue addressing infrastructure gaps particularly at Länder and municipal levels by rebuilding planning capacity and improving coordination across government levels.
- Federal fiscal relations reform, Municipal Investment Promotion Fund, Digital Infrastructure Fund, and technical expertise via Partnerschaft Deutschland are positive steps; stronger coordination needed for larger and longer-term projects.
- Construction industry price pressures and capacity constraints are emerging obstacles.
Structural reforms (digital, startups, energy)
- Digital infrastructure
- Budget allocation up to EUR 12 billion and strategy to support a nationwide high-performance network through 2025 are welcome, but expansion progress remains slow due to capacity constraints and insufficient private-sector incentives.
- Implement the “National E-Government Strategy” rapidly to reduce administrative costs and improve public service delivery.
- Start-up environment
- Investment in start-ups increased, aided by government initiatives; further scope to scale up venture capital by attracting institutional investors and cross-border flows within the EU.
- Energy transition
- Germany on track to meet renewable energy target but faces challenges building internal electricity transmission capacity and uncertainty on how greenhouse gas emission targets will be met.
- Government decision to phase out coal-fired power production by 2038 per the Commission on Growth, Structural Change and Employment (January 2019).
- Consideration of a carbon tax as part of the solution.
Financial stability (assessment and actions)
- Banking and insurance sector health
- Banks appear well capitalized on risk-weighted terms and hold appropriate liquidity, but profitability is low in important parts of the sector and leverage is high among large banks compared to peers.
- Large banks underperform European peers in market valuation due to high costs, operating weaknesses, and in some cases provisions for compliance violations.
- Low interest rates pressure interest margins at small- and medium-sized banks.
- Life insurance sector faces resilience challenges; replacement of guaranteed-return products should proceed faster.
- Macro-financial vulnerabilities
- Low default rates led to a substantial decline in risk provisions; some banks reduced risk weights via internal ratings-based approaches.
- Evidence of “search-for-yield” behavior.
- Residential and CRE prices continued to rise; price increases have not been accompanied by strong aggregate credit growth, but lack of granular residential real estate loan data hinders full risk assessment.
- Macroprudential recommendations
- Gradually raise the counter-cyclical capital buffer to enhance banking resilience without materially altering credit supply.
- Urgently address data gaps; the one-off bank survey on real estate lending and corporate credit underwriting standards is positive, but regular granular data collection is needed for effective macroprudential policy-making.
- Consider early implementation of existing borrower-based measures (cap on loan-to-value ratio and amortization requirements) on residential mortgage lending.
- Consider expanding the toolkit with income-based instruments (cap on debt-service-to-income, cap on debt-to-income) for residential loans and appropriate borrower-based measures for CRE loans.
- Supervisors should monitor interest rate risk and progress in implementing adjustment plans in banking and insurance sectors.
Mission thanks the authorities for their hospitality, cooperation and willingness to engage in extensive and frank policy discussions.