Transcript

Transcript of a Conference Call on Germany
With Ajai Chopra, Mission Chief to Germany and Senior Adviser in the European Department; Robert Corker, Assistant Director in the European Department; and Tomas Balino, Senior Adviser in the Monetary and Financial Systems Department
Thursday, November 6, 2003
Washington D.C.

MS. LOTZE: Good morning, everyone. I'm Conny Lotze of the External Relations Department, and I would like to welcome you to this conference call on Germany.

As you know, the Executive Board discussed the Article IV staff report, the Financial System Stability Assessment, and the Selected Issues Paper on Monday.

Mr. Chopra will make some introductory remarks, and then we'll open the floor to questions. Mr. Chopra, please?

MR. CHOPRA: Good morning or, depending on your time zone, good afternoon. I'm Ajai Chopra.

This year's Article IV consultation is quite a bit broader than previous ones because of the Financial Sector Assessment Program, or the FSAP for short. There have already been several press reports about our conclusions, covering both economic policies in general and the financial system.

Although it appears that you're all quite well informed, I'd like to take this opportunity to provide a brief overview of the main points and to correct any misperceptions that have been reported.

But before we get started, a quick advertisement for what has been posted on the IMF website today. You, of course, get the usual staff report, but in addition to that, you'll be getting what's called the Financial System Stability Assessment, which is the FSAP report, and also some background analytical papers. One of these background analytical papers is a detailed analysis of the three-pillar banking system.

In addition, there is the Public Information Notice, or the PIN, which is also being posted on the website, and the PIN that contains the assessment of the IMF's Executive Directors. As Ms. Lotze just mentioned, Mr. Balino, the leader of the IMF FSAP team, is also available here to take your questions after my opening remarks.

Now, let me just turn to a brief—something brief on economic policies, and I'd like to make three points over here. The first is that we are very pleased with Germany's new emphasis on structural reforms. Agenda 2010 is very much in the direction of what we have been calling for from the IMF. This is especially so in the area of labor markets, where the reform of unemployment benefits and of social assistance is a very important measure. But also in the area of health and pensions, there are some very, very good beginnings. They don't solve all of Germany's structural problems. The pension and health measures will take us perhaps a third to one-half of the way to addressing the long-term aging costs, and the labor market reforms will also need to be augmented over time, especially to further prod the unemployed to accept jobs that are offered and to deregulate hiring and firing. But, again, I should emphasize that these are a fine beginning when it is all put together and it is all implemented.

Second, we see the reforms as having a positive impact on confidence, but, nonetheless, we remain quite cautious about the near-term outlook. The reforms will have most of their impact on the economy over the medium term. That's just the nature of the structural reforms. But on the near-term outlook, it's our view that the likelihood of recovery is stronger now than it has been in the last three years, and this is especially so with the U.S. economy once again taking the lead.

Yet, as demand is still weak in Europe and given the appreciation of the euro and the fiscal constraints, it's not reasonable for us to expect strong growth in the period immediately ahead.

So coming now to the specific numbers, for 2003 we expect zero percent growth, and for 2004 we are forecasting growth of one and a half percent.

However, for once, we believe that the risks are balanced. By that I mean there's just as much upside potential as there is downside risk. This, I should mention, is in contrast to previous forecasts where we have had a pessimistic leaning.

The third point on economic policies is that the 2004 budget is shaping up to be a reasonable compromise between competing fiscal demands, the competing fiscal demands being the need for fiscal consolidation, on the one hand, and the need to provide some support to demand, given the weak cyclical conditions on the other hand.

With tax cuts, the deficit will not be brought under 3 percent of GDP in 2004, in our view. Specifically, for 2003, we expect the deficit, the general government deficit, to exceed 4 percent of GDP. The tax cuts are going to add another 1 percent of GDP to the deficit next year. So when you put all this together, this would mean that to bring the deficit below 3 percent, it would require offsetting budget cuts elsewhere of more than 2 percent of GDP.

This is daunting under any circumstances, and it doesn't look very realistic to us, and it's also potentially damaging from a cyclical perspective.

From our estimates, we see that the measures that are on the table and being discussed in Germany now, the fiscal measures, amount to about 1 percent of GDP. So if there isn't particularly strong growth based on our growth forecast, which is for a very moderate recovery, we would expect the nominal deficit in 2004 to remain just around 4 percent of GDP.

But there is a silver lining, and that is that the quality of the measures, especially the cuts in subsidies and tax expenditures, some of the measures being taken on entitlements, all of these are high-quality, durable, structural measures, and this is exactly the sort of thing that in our view Germany ought to be doing. And these sorts of measures are much better than the ad hoc measures that were typically implemented in the past.

Nevertheless, we do say in our report that the German authorities need to go deeper and further, especially in 2005 and 2006, if the government's fiscal consolidation plans are to have the required degree of credibility.

Specifically in the report, we suggest that the structural deficit should be reduced by at least 1.5 percent over 2004 to 2006, over those three years. And based on what we see right now, this means that the government will still need to find additional fiscal measures of about 1 to 1.5 percent of GDP over this period, given the size of the tax cut.

Having talked about the general economic policies, I am now going to turn to the FSAP, and, again, I'd like to make three points.

The first is that the analysis and the stress test that we have done on the financial system points to a welcome degree of resilience for the system. After what was perhaps the worst period in memory, it looks like the financial system is recovering. This has, of course, been helped by the improvement in financial markets, but also the banks' restructuring efforts, what they've been doing on their own in response to the difficulties that they faced.

The financial system is not completely out of the woods, and the low profitability of banks, which has been on a declining trend for the last decade or so, does need to be addressed to forestall future problems. Consolidation in the insurance sector is also necessary.

The second point is that, as I said, given that the banking system is not completely out of the woods, banks do need to further accelerate and deepen their restructuring. And it is here that I should say that our conclusions have been misrepresented on occasion based on some of the reports we've seen.

What I'd like to emphasize is that we do not have a blueprint of how such restructuring should take place in the period ahead. That is to say, we are not ideologically opposed to any particular type of bank in Germany, including cooperatives and the Sparkassen. We do, however, see major advantages in allowing the markets to guide restructuring.

The banking system will need more capital, and Germany will probably need fewer banks. To channel capital to the most innovative and efficient banks, we feel that some legal changes are going to be needed, changes in the legal framework.

There is, in our view, a case for public banks to be at least corporatized and for banks to be able to merge across different pillars. At the same time, competition in a more consolidated and innovative financial system in our view can be preserved if we allow banks to operate beyond their current regional borders.

Third, and finally, on the FSAP, we do see a need for bank privatization over the medium term. Again, this is not an ideological point, but the plain fact is that we see little justification for public ownership of nearly half of banking sector assets in a country such as Germany. This is a point that is covered in considerable detail in the three-pillar banking paper, and I would very much encourage you to read the specific arguments in that paper.

MR. BALINO: This is Tomas Balino, the head of the FSAP mission. I would just add to what Mr. Chopra has said that the FSAP mission was very impressed with the quality of financial sector supervision in Germany; and that the creation of BAFin (Bundesanstalt für Finanzdienstleistungsaufsicht) and the cooperation with Bundesbank in banking supervision are going well.

There are areas, of course, where we have views of some adjustments that need to be made. Particularly, we believe that in the insurance sector there is a need to strengthen the supervision, particularly of reinsurance. That, I would emphasize, is not just an issue for Germany, but it's an issue that is on the international supervisory agenda these days, and there are likely to be norms introduced. Some of them will be coming in Europe issued by the European Commission, but Germany seems to be willing to be in the forefront of that. That's all I have to say.

MS. LOTZE: That was the introduction, and we turn to questions now, please.

QUESTIONER: Did you receive any reaction from the German government to your report already?

MR. CHOPRA: Yes, we have indeed. As you perhaps know, in the context of an Article IV consultation, this is very much a dialogue between the IMF staff and the German authorities. When we were on mission, there was broad agreement on virtually all the aspects. I think as you will see, in our staff report we report both the staff's views and also the views of the German authorities.

I would think on most of the structural issues we see very much eye to eye in terms of the steps that are being taken on labor market reforms, the steps that are being taken in health care, on pensions. We also see very much eye to eye in terms of the medium-term fiscal targets and the objectives.

I think the German authorities would agree with our estimate that the measures that the fiscal measures that are on the table take us about halfway there in terms of the required adjustment. So I think there is a very high degree of broad agreement on both the diagnosis and the prescription.

On the financial sector, as you can imagine, I think even here there is a high degree of concordance in our views. There might, of course, be some differences in nuance or in the speed with which certain changes need to take place. You should also keep in mind that from the IMF our discussions are primarily, at least at the government level, are with the federal government. There are, of course, a number of policy measures over here that are connected with decisions that have to be made by Länder governments, and at this point I should say that our dialogue with the Länder governments is not at the same level as it is with the federal government.

QUESTIONER: Mr. Chopra, you said that it might be potentially damaging from a cyclical perspective, also politically difficult to keep the deficit below 3 percent next year. So do you suggest that the government shouldn't even try? And how do you judge the damage done to the European Stability Pact?

MR. CHOPRA: I think here I would point you to the discussion in the euro area paper of the IMF because we also, in addition to having consultations, bilateral consultations with various countries in the euro area, we also have regional consultation with the ECB and the European Commission. And the euro area paper outlines the position with regard to things such as the Stability and Growth Pact.

For Germany, I should say that the way we see it—and this is consistent with the line that was taken in the euro area paper—is that there is a tradeoff between short-term consolidation and medium-term commitments to implement structural reforms that assist both growth and fiscal consolidation.

Germany's fiscal problems are not short-term problems. These are long-term problems, and they have to be addressed with strong structural measures. And that's what we see the German authorities as doing, and that's why we think that this is the course to take.

In terms of how this fits in with the Stability and Growth Pact, that is, of course, up to the European Commission and the Finance Ministers to decide. That's not in our bailiwick.

But I should also point out that, as we see it, the fiscal accounts for 2004 as they're shaping up, they do—even these fiscal accounts—even this budget would imply a modest fiscal contraction. The point is that it's somewhat less contractionary than under earlier baseline scenarios. But, again, what I would emphasize is that the government is indeed taking steps to address the long-term fiscal situation.

MS. LOTZE: Thank you very much. We'll close the conference call here. Thank you very much for participating.

[Whereupon, the conference call was concluded.]