Germany: 2011 Article IV Consultation Concluding Statement of the IMF Mission
May 17, 2011
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.
With Germany called on to assist the global recovery, questions about its current account surplus have resurfaced, and Germany’s wage moderation and proposed pace of fiscal consolidation have, at times, been regarded with concern. However, more rapidly raising wages or delaying fiscal consolidation could compromise German strengths with dubious short-term stimulative value for other countries. The real German challenge is to strengthen its areas of weakness. The key is to counteract medium-term growth constraints in a way that also supports sustainable rebalancing via higher domestic demand growth. This would also be good for Europe and the global economy. Similarly, a robust German financial system is important for both German and global financial stability. Given the system’s large size, its international connections, and the nonlinear behavior of these connections at times of stress, the forward-looking development of stronger German systemic shock absorbers is vital.
1. Enduring strengths and supportive short-term policy measures have helped achieve a robust recovery from the crisis. The proficiency of its industry, along with a sizeable, internationally-coordinated fiscal stimulus and financial sector stabilization measures, helped Germany establish a recovery with over 3 percent GDP growth in 2010 and, possibly, in 2011. The subsidy for reduced work-time hours helped retain employees, complementing existing flexibility in contractual arrangements. The German economy and employment are above levels before the onset of the Great Recession, an achievement realized by only a few advanced economies. Considerable optimism prevails.
2. Fulfilling the upbeat expectations will require raising the economy’s growth potential and securing financial stability. Despite justified optimism, growth can be projected to slow in the short term as the fiscal consolidation takes hold, the output gap closes, and world trade growth slows after its bounce back. This could be accompanied by global and domestic inflationary pressures. Moreover, absent a new generation of longer-term policy measures, German economic growth would drift down to its potential growth rate, estimated at about 1¼ percent annually. Securing financial stability is needed to prevent disruptions and further claims on public finances.
3. The ongoing recovery offers a propitious context for tackling long-standing structural problems. The commitment to fiscal consolidation is strong, and the German leadership in this area carries potential long-term benefits for Europe. In other areas, however, the political momentum for reform appears weak. Stepping up potential growth would require important measures in areas such as tax policy and educational reform, which while widely understood, need to move up in policy priority and implementation. In financial sector policy, the new bank resolution framework is welcome, but in other long-standing matters, German authorities have been generally reactive to European initiatives. The political constraints to action will only increase if these challenges are confronted in a low-growth environment.
4. The policy dialogue should be shaped by a perspective that enhanced economic well-being in Germany can also contribute to global growth and stability. German growth fluctuations have largely been driven by external developments. Despite a more prominent role for domestic demand in the cyclical recovery, a durable rebalancing is needed. Better growth prospects (through a stepped-up growth potential particularly in the non-tradable sector) would generate a reinforcing combination of supply and demand responses. As the productive potential increases, confidence in a better future will raise the economy’s notably low investment rate and boost consumption growth. Such autonomous demand would create more of an international locomotive role for Germany, while narrowing its current account surplus by addressing these underlying structural factors.
5. The growth agenda must be multi-pronged. Increased labor participation, especially among women, the low-skilled, and the elderly is needed to counteract the declining workforce. In turn, labor needs to be more productively deployed, requiring complimentary physical investment and innovation, especially in areas outside Germany’s traditional strengths. Productivity gaps in the services sector require greater usage of information and communication technology, where Germany can close the gap with the international frontier.
6. Each of these goals requires specific measures to be effective. Tax policy, complemented by measures to remove disincentives to work, can help raise labor participation. These measures need to focus on higher participation amongst the targeted groups, for example, through a system of tax credits. The investment climate would be improved by eliminating local trade taxes, thereby reducing the effective corporate tax rate, and by a reduction of the debt bias in corporate financing. The key components of needed educational reform include more widespread early childhood care and education, reorienting vocational training to emphasize lifelong learning, and further upwards mobility within the education system. Enhanced provision of risk capital may require removing tax ambiguities and a more efficient insolvency process.
7. The government’s fiscal consolidation path is appropriate. With the output gap closing, consolidation would help dampen short-term inflationary tendencies. Longer-term considerations are, however, more decisive. The public debt-to-GDP ratio is above 80 percent, boosted by obligations for financial sector support. Germany has a commitment to its own fiscal rule and to the preventive arm of the European Stability and Growth Pact (SGP), requiring a structural balance close to zero at the latest by 2016. By adhering to these mechanisms to regain lost ground and ensure fiscal sustainability, Germany would enhance its fiscal credentials and support the SGP.
8. Consolidation must, however, build room for responding to exceptional negative surprises and for fostering growth. A reassessment of the speed of consolidation may be needed in line with the fiscal rule if growth turns out to be significantly weaker than expected. Moreover, space is required within the consolidation envelope for initiatives to foster the growth agenda. To maintain fiscal neutrality, these could be offset by higher property and inheritance taxes, elimination of reduced VAT rates, as well as measures to increase the efficiency of education spending.
9. The financial system is broadly stable but pockets of vulnerability remain. Following extended public support through recapitalization funds and guarantees on bank funding provided by the Financial Market Stabilization Fund (SoFFin), several banks have since been able to attract private capital and long-term funding. This has improved capital ratios at banks to levels that could absorb considerable stress (as determined by the parallel Financial Sector Assessment Program Update). Nevertheless, German banks remain highly leveraged, achieve low profitability, and the large banks remain highly dependent on market funding. These vulnerabilities apply with particular force to certain financial institutions, most prominently some Landesbanken. The delays in data publication and the lack of transparency in crucial areas—including the financial strength of the deposit insurance schemes and the financial relationships between the Sparkassen and the Landesbanken—are troubling. Moreover, while the overall level of direct exposure to the European periphery is limited, some banks are more exposed than others, and indirect effects through banks outside of Germany could have cascading effects.
10. The legacy of the crisis requires continuing attention. The effort must be to carve out the credibly viable segments of the banks under the care of the Federal Agency for Financial Market Stabilization with a view to returning them to the market at an early date. Similarly, the ongoing effort to reduce the Government’s silent participation in banks must continue. And where winding-up institutions have been created, their assets must also be sold at a deliberate pace that avoids firesales but reduces delays that could cause the assets to lose value. The Landesbanken restructuring is proceeding on an opportunistic basis, under the European Commission’s state aid principles. A more ambitious restructuring process will further reduce misplaced incentives to search abroad for yields and contribute to rebalancing by strengthening domestic investment.
11. Clarity on the regulatory and supervisory regime is overdue. The need for more proactive supervision is a key and well-understood lesson from the last crisis. This lesson is guiding a more forward-looking regulatory and supervisory process in Germany. However, continued lack of clarity on key issues could be an impediment. These areas include the interactions and the sharing of information between the Bundesbank, BaFin, and the European Supervisory Authorities, as well as the content of macro-prudential oversight likely to be designated to the Bundesbank and the relationship between macro- and micro-prudential regulation. Early consideration is needed to prevent risks slipping through the cracks.
12. Proactive financial sector initiatives will also contribute to European financial integration. With the crisis receding, the sense of urgency on more far-reaching objectives is fading. Two issues, in particular, deserve attention:
• Private deposit protection and mutual protection schemes tied to Germany’s “three-pillar” banking system, while permissible under European directives, pose risks to Germany. The lack of legal certainty on the payouts under the pillar schemes and the absence of transparent financial reporting on their health are a stability concern. That one scheme was severely tested during the crisis is further reason to be concerned. The availability of this extended protection, despite legal uncertainty, may create a competitive advantage for German bank branches elsewhere in Europe. A move towards common, statutory payout obligations across the pillars could be a prelude to their eventual unification to realize economies of scale. Unified statutory schemes would also allow for the possible use of their resources for early intervention and, hence, realize synergies with the restructuring fund (whose activation relative to the existing instruments available under the pillars’ schemes also requires clarification).
• The Sparkassen hold a time-honored position in German banking and have emerged from the crisis with a demonstration of stability. Nevertheless, it is not too early to consider the longer-term challenges and stability risks they face. They have sizeable exposure to the Landesbanken, one large Sparkasse faced significant financial stress during the crisis, their valued deposit base will increasingly be under contest as European financial integration—particularly internet banking—unfolds, and adequate returns will be required on the higher and better-quality capital. With the costs they have borne for supporting the Landesbanken, it is not surprising that some Länder have allowed for private ownership of Sparkassen, though yet without voting rights. A gradual shift to private ownership, while carving out their public functions, is a tested process elsewhere in Europe and deserves serious consideration.
13. We, the mission team, are most grateful to the authorities for their generous hospitality and always focused and constructive discussions.