Public Information Notice No. 11/87

Public Information Notice: IMF Executive Board Concludes 2011 Article IV Consultation with Germany

July 12, 2011

On July 6, 2011, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Germany.¹

Background

In the first quarter of 2011 German GDP surpassed its pre-crisis level following growth of 3½ percent in 2010, and employment is higher than before the crisis. Staff projects the economy to expand by a healthy 3 percent in 2011, but growth is expected to slow as the fiscal consolidation takes hold, the output gap closes, and world trade growth decelerates. While Germany escaped the crisis with little permanent damage, its long-term growth prospects remain low (about 1¼ percent annually).

Rising commodity prices will temporarily lift German headline inflation from 1.2 percent in 2010 to 2½ percent in 2011. Core inflation, however, is projected to rise only moderately. Germany’s current account surplus, which rose to about 7½ percent of GDP just before the Great Recession, has since receded to about 5 percent of GDP.

The authorities injected a sizeable fiscal stimulus in 2009–2010 to counteract the economic downturn. With the economic recovery, they are moving towards a gradual consolidation. The pace of the recovery and the consolidation efforts imply that the objective of the European Union’s Stability and Growth Pact (SGP), to bring the deficit below 3 percent of GDP, can be achieved in 2011. The goal of the national fiscal rule, which targets a close-to-zero structural fiscal balance at the Federal level by 2016, is also within reach. The increased primary surplus will help bring down the debt-to-GDP ratio from its current level of over 83 percent of GDP (having been boosted recently by banking sector support) to 73 percent of GDP by 2016.

The banking system’s return to broad stability reflects both the significant policy measures and the economic recovery. The German authorities injected significant capital into banks and provided the safety net of sovereign guarantees to access market financing during the crisis. In 2010 banks have raised their capital ratios and asset quality has also improved. However, pockets of vulnerabilities remain. Banks continue to be highly leveraged and the quality of their capital is low by international standards. Their profitability is also relatively low and expected to remain so.

Executive Board Assessment

Executive Directors welcomed Germany’s impressive recovery buoyed by the strength of the export sector and supportive policies, including a fiscal stimulus and targeted measures to support the labor market and stabilize the financial sector. Directors underscored, however, the importance of structural measures targeting labor, capital, and productivity to raise medium-term potential growth and domestic demand, particularly in the non-tradable sector, which would also support the role of Germany as an international locomotive and contribute to a reduction of global imbalances.

Directors observed that a multi-pronged agenda that tackled long-standing structural issues could raise potential output growth. The implementation of such an approach, whose goal would be to boost labor participation, domestic investment, and productivity, would include tax, education, and innovation policies, complemented by an enhanced provision of risk capital and a more efficient insolvency process.

Directors noted that the government’s fiscal consolidation path, while appropriate, needs to allow room for fostering growth. They observed that, with the output gap closing, lowering the public debt-to-GDP ratio will enhance credibility and support the European SGP. Directors noted, however, that a reassessment of the speed of consolidation may be needed if growth turns out to be significantly weaker than expected. They also observed that the use of fiscal instruments for stimulating growth should stay within the planned consolidation path.

Directors considered that the German financial system has stabilized, although pockets of vulnerability remain. Improved capital ratios imply that the banks could absorb considerable stress. Nonetheless, Directors noted that German banks remain highly leveraged, achieve low profitability, and the large banks remain highly dependent on market funding. While the overall level of direct exposure to spillover risks from elsewhere in Europe is limited, some banks are more exposed than others and indirect effects through banks outside of Germany could have cascading effects. Directors also encouraged a more timely publication of key financial data and enhanced transparency of the regulatory and supervisory regime, the operations of public sector banks, and the deposit insurance schemes.

Directors stressed that actions to limit systemic risk in the financial system are required in a number of areas. First, the legacy of the crisis needs to be addressed, including establishing viable business models for the Landesbanken. Second, the regulatory and supervisory regime should be strengthened through clarification of the content of macro-prudential oversight, the relationship between macro- and micro-prudential regulations, and the necessary information sharing requirements. In this context, ensuring adequate and high-quality bank capitalization is important, especially where systemic risk considerations arise. Third, harmonization of the various deposit insurance schemes would allow for the possibility of the use of their resources for early intervention and help realize synergies with the restructuring fund. Finally, the role of the Sparkassen would need to be considered in the context of an integrated and competitive European financial system.