Journal Issue

Germany: Staff Report for the 2015 Article IV Consultation

International Monetary Fund. European Dept.
Published Date:
July 2015
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Recent Economic Developments and Outlook

A. The Economy Remains on an Uptrend

1. An upturn is under way as the economy is enjoying the benefits of the euro depreciation and lower energy prices. The anticipation of the ECB’s quantitative easing (QE) significantly lowered interest rates and term spreads, weakened the euro, and, together with the drop in energy prices, helped overcome the unexpected slowdown of mid-2014 (Figure 1). By the end of last year and into the first quarter of this year, investment picked up again while consumption was supported by above-trend real disposable income growth. The latter benefited from robust real wage growth, a strong labor market, and the positive demand effects of the pension reform implemented last year (higher pensions for some mothers, and earlier statutory retirement for some categories of workers). The regained domestic demand momentum boosted imports, while the weaker euro during the second half of the year helped strengthen export performance in spite of a slowdown in emerging markets.

Figure 1.Germany: Growth Outlook

Source: Destatis, Haver Analytics, IFO Institute, INS, IMF World Economic Outlook, Markit, and IMF staff calculations.

Note: EA5=Euro area economies (Greece, Ireland, Italy, Portugal, Spain) with high borrowing spreads during the 2010-11 sovereign debt crisis.

The Effect of QE on Financial Markets

(Cumulative changes from August 22, 2014)

Sources: Bloomberg and IMF staff calculations.

2. The oil price drop brought inflation temporarily close to zero, contributing to lift real wage growth to a twenty-year high. Core inflation is low and stable at around 1 percent, while real compensation per employee increased by 1.7 percent in 2014 (Figure 2). Employment kept growing strongly—though the trend in total hours worked has been less dynamic—and the unemployment rate hit another post-reunification low at 4.7 percent, while Germany became the second largest migration destination in the world after the U.S. last year. Recent collective agreements and ongoing wage negotiations suggest continued significant real wage growth this year. The new minimum wage, introduced on January 1, 2015 and implemented over two years, has had no visible impact on total employment so far.

Figure 2.Germany: Prices and Labor Market

Source: Bundesbank, Federal Statistical Office, Eurostat, Haver Analytics, and IMF staff calculations.

Germany: Current Account and Sectoral Saving-Investment Balances

(Percent of GDP)

3. The current account surplus continued to grow in 2014, reaching 7.6 percent of GDP. The narrowing of the oil and gas trade deficit was the main contributor to the expansion in the surplus (Figure 3), which was the largest in the world in USD terms. The surplus vis-à-vis euro area economies (Greece, Ireland, Italy, Portugal, Spain) with high borrowing spreads during the 2010-11 sovereign debt crisis was stable after declining substantially during the crisis. Regarding saving-investment balances, non-financial corporations and the general government increased their surpluses in 2014 relative to 2013. In fact, the surplus of non-financial corporations, at 2.2 percent of GDP, reached its highest level since reunification. The CPI-based real effective exchange rate was roughly stable in 2014, but has since depreciated by 6 percent from its 2014 average primarily because of nominal depreciation vis-à-vis the dollar and the renminbi. The net international investment position (NIIP) continued to grow in 2014, reflecting stronger direct and portfolio investment positions. Yet, monetary and financial institutions cut back their net foreign lending position, continuing a trend observed since 2009.

Figure 3.Germany: Balance of Payments

Source: Bundesbank, DOTS, GDS, Haver Analytics, IMF World Economic Outlook, and IMF staff calculations.

1/ Countries included in the calculations are Australia, Austria, Belgium, Canada, Colombia, Denmark, Estonia, Finland, France, Greece, Hong Kong SAR, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Singapore, Slovak Republic, Slovenia, South Africa, Spain, Suriname, Sweden, Switzerland, Taiwan Province of China, United Kingdom, and United States. Note: EA5= Euro area economies (Greece, Ireland, Italy, Portugal, Spain) with high borrowing spreads during the 2010-11 sovereign debt crisis.

4. Fiscal policy was mildly contractionary in 2014, while it is expected to turn mildly expansionary in 2015. The government presented a balanced federal budget for 2015, one year ahead of schedule (Figure 4). The general government surplus rose to 0.6 percent of GDP in 2014—a structural improvement of 0.3 percent relative to 2013—owing to lower-than-expected interest payments and one-off revenue items. A negative interest rate–growth rate differential pushed the debt ratio further down, to 74.7 percent of GDP. The structural fiscal position for 2015 is expected to remain comfortably within the boundaries set by the constitutional debt brake rule at the federal level and the European Medium-Term Objective (MTO) at the general government level (maximum structural deficits of 0.35 percent and 0.5 percent of GDP, respectively).

Figure 4.Germany: Fiscal Developments and Outlook

Sources: Federal Statistical Office, Ministry of Finance, and IMF staff calculations and projections.

5. Credit growth remains tepid despite record-low interest rates. The yield on 10-year bunds, after reaching a trough of 0.1 percent in mid-April, recently rebounded sharply as market volatility suddenly jumped—possibly reflecting lower market liquidity—but remains very low from a historical perspective, with negative yields extending up to the 3-year maturity. Already historically low bank lending rates have fallen further with the anticipation of QE (Figure 5), while stock prices have accelerated sharply. So far, however, credit growth has remained subdued, especially in the corporate sector, where companies can finance a large share of their investment needs from retained earnings and cash reserves, resulting in low credit demand. A more dynamic housing market (especially in some “hot spots”) over the past few years has been accompanied by tepid aggregate mortgage lending growth, although there are signs of acceleration in recent months.

Figure 5.Credit Conditions and Asset Prices

Source: ECB, Haver Analytics, and IMF staff calculations.

6. The Single Supervisory Mechanism’s (SSM) Comprehensive Assessment revealed only minor shortcomings in loan classification or provisioning but showed relatively low capital quality and leverage ratios in the large-bank segment of the banking sector. As expected, the higher provisioning needs identified by the asset quality review were concentrated in shipping finance and commercial real estate portfolios. All assessed banks, except a relatively small one, passed the stress tests. This very positive outcome was partially due to the fact that some types of capital that are being phased out under the new European regulation were still counted as eligible for the exercise.1 Furthermore, while banks’ leverage ratio is currently not subject to EU-wide regulation, SSM disclosures showed that many of the largest German banks had leverage ratios close to or below 4 percent (Figure 6), a level emerging as the new regulatory minimum in a growing number of European countries (Netherlands, Switzerland, U.K.).

Figure 6.Germany: Recent Developments in the German Banking Sector

Source: Bloomberg, ECB, IFS, SNL Financial, and IMF staff calculations.

1/ Includes capital raised during January- September 2014.

B. Outlook and Risks

7. The more favorable external environment should support the growth momentum. The robust private consumption dynamics of the past three quarters is projected to persist with the help of lower energy prices and strong real wage growth. The euro depreciation and lower real interest rate (as QE pushes up inflation expectations) should buttress exports as well as the long-awaited recovery in machinery and equipment investment. Although corporate credit demand is expected to remain muted in a context of cash-rich corporate balance sheets and increasing profit margins for exporters, QE-induced lower real interest rates should translate into somewhat firmer credit growth. The fiscal stance should remain slightly expansionary in 2016 (see below). Employment growth should slow down as the adverse effect of the lower statutory retirement age for some categories of workers on labor force participation kicks in fully and the already low unemployment rate becomes harder to reduce further. All in all, GDP is expected to grow by 1.6 percent this year and 1.7 percent next year. The output gap should close this year and remain positive but small in the medium term. Together with a better anchoring of expectations because of QE (and despite only limited expected pass through from the exchange rate depreciation and the introduction of the minimum wage) this positive output gap should gradually push up core and headline inflation. Although German inflation is expected to exceed that in the rest of the euro area throughout the forecast horizon, it is not projected to rise above the ECB price stability objective.

8. Fiscal balances are set to remain comfortably within the boundaries of the fiscal rules. For the remainder of the legislature (2015–17) and beyond, budget plans are centered on a zero balance at the federal level with small surpluses for the general government, backed by buoyant revenue forecasts. Staff expects larger surpluses than the authorities, mostly on account of lower projected interest payments (Table 2), enough to bring public debt below 60 percent of GDP by 2020. Although the structural fiscal balance is expected to decline by 0.6 percent of GDP through 2015–17, debt sustainability analysis shows that the medium-term position is well anchored by the fiscal rules (see Appendix IV).

Table 1.Germany: Selected Economic Indicators, 2012-16
Total population (2014, million)81.1
GDP per capita (2014, USD)47,615
(Percentage change)
Output gap (In percent of potential GDP)0.4−0.6−
Private consumption0.
Public consumption1.
Gross fixed investment0.0−
Machinery and equipment−2.3−
Final domestic demand0.
Inventory accumulation 1/−1.40.1−0.3−0.30.1
Total domestic demand−
Exports of goods and
nonfactor services3.
Imports of goods and
nonfactor services0.
Foreign balance 1/1.4−
(In millions of persons, unless otherwise indicated)
Employment and unemployment 2/
Labor force41.341.641.842.042.1
Unemployment rate (in percent)
(Percentage change)
Prices and incomes
GDP deflator1.
Consumer price index (harmonized)
Compensation per employee (total economy)
Unit labor cost (manufacturing)
Real disposable income 3/
Household saving ratio (in percent)
Sources: Deutsche Bundesbank; Federal Statistical Office; IMF staff estimates and projections.
(In billions of euros, unless otherwise indicated)
Public finances
General government
(In percent of GDP)44.244.344.043.843.5
(In percent of GDP)44.344.544.644.443.8
Overall balance 4/34181612
(In percent of GDP)
Structural balance01421126
(In percent of GDP)
Federal government
Overall balance 4/−15−4131211
(In percent of GDP)−0.5−
General government debt2,1802,1662,1702,1352,110
(In percent of GDP)79.377.174.770.667.9
(In billions of U.S. Dollars, unless otherwise indicated)
Balance of payments
Current account240.8241.7292.0284.8276.0
(In percent of GDP)
Trade balance 5/1951.61959.52018.22138.52254.9
Services balance420.5446.4457.8482.8511.0
Factor income balance66.860.266.962.563.4
Net private transfers−25.8−26.2−24.3−24.3−24.3
Net official transfers−14.4−14.9−13.1−14.7−15.7
Foreign exchange reserves (EUR billion, e.o.p.) 6/28.828.130.6
(Percentage change)
Monetary data
Money and quasi-money (M3) 6/7/
Credit to private sector 6/
(Period average in percent)
Interest rates
Three-month interbank rate 6/
Yield on ten-year government bonds 6/
Exchange rates
Euro per US$0.760.730.81
Nominal effective rate (1990=100) 6/98.1101.599.8
Real effective rate (1990=100) 6/96.599.797.3
Sources: Deutsche Bundesbank; Federal Statistical Office; IMF staff estimates and projections.
Table 2.Germany: General Government Operations, 2012-20
Revenue 1/44.344.544.644.443.843.943.944.144.1
Indirect taxes11.311.
Direct taxes11.311.711.811.811.711.711.811.911.9
Social contributions16.516.616.616.516.516.616.616.916.9
Other current revenue5.
Compensation of employees7.
Goods and services4.
Social benefits23.523.723.824.
Social benefits in kind7.
Social transfers15.615.715.615.615.515.615.515.415.4
Child benefits0.
Unemployment benefits1.
Other social transfers4.
Other expense5.
Net acquisition of nonfinancial assets−0.2−−
Net lending/borrowing0.
Primary balance2.
Memorandum item:
Structural balance0.
Change in structural balance1.00.50.2−0.3−
Public gross debt (Maastricht definition)79.377.174.770.667.965.362.659.657.0
Sources: Ministry of Finance; Bundesbank; Federal Statistical Office; and IMF staff estimates and projections.

9. The current account surplus is projected to grow further in 2015 and decline only moderately in the medium term. The oil and gas trade balance is expected to continue to improve as energy prices remain lower on average than in 2014. In addition, the real exchange rate depreciation (of 6 percent in effective terms relative to 2014) will also put upward pressure on the external balance. As a result, the surplus is expected to exceed 8 percent of GDP, a record high, and decline gradually to 6.7 percent in 2020, as the terms of trade windfall is gradually spent, private investment recovers modestly, and stronger wage growth relative to euro area trading partners contributes to realign competitiveness.

10. Risks to the baseline are more balanced than a year ago, but important sources of uncertainty remain. There is upside risk to the outlook if the stimulus from monetary policy and oil prices that is in the pipeline proves more effective than expected. On the downside, a number of external risks could affect Germany, with possible impact ranging from low to moderate (see Appendix I):

  • A protracted period of slower growth in key advanced and emerging economies or a deeper-than-expected slowdown in China would dampen economic activity in Germany. Unusually for a large economy, Germany is very open, with an exports-to-GDP ratio over 45 percent, and thus highly sensitive to external demand fluctuations. While the geographic structure of exports is well diversified, a simultaneous shock to major emerging economies would have a sizable impact on Germany (Box 1).

  • Renewed stress in the euro area, triggered by policy uncertainty, faltering reforms, or political unrest in some countries might erode confidence and postpone once again the projected investment recovery. Further monetary stimulus at the euro area level would be forthcoming in this scenario, but it may need to be reinforced by demand-support measures in Germany.

  • Uncertainty about the persistence of the oil supply shock and the underlying price decline could undo part of the recent improvement in consumer and business confidence, both domestically and in key trading partners. This would be a low-impact shock.

  • An escalation of trade sanctions with Russia would hurt Germany because of its heavy dependence (30 percent) on oil and gas imports from that country and might require a reform of the energy strategy. Other direct trade ties and financial exposures are limited. Germany could also experience safe haven inflows if tensions rise.

Authorities’ Views

11. The authorities agreed with staff that the moderate expansion of the German economy is likely to continue. They expressed confidence in a consumption-led upswing, amid lower energy prices as well as solid wage growth underpinned by a tight labor market and closed output gap. While they concurred with staff that inflationary pressures would be muted this year, the Bundesbank underscored that prices were likely to accelerate owing to pass-through from exchange rate depreciation as well as the introduction of the minimum wage and recent wage dynamics more generally, so that inflation would reach close to 2 percent in 2016. The authorities agreed that the current account surplus would decline only gradually. They also concurred that public debt is well-anchored by EU and national fiscal rules, although they foresaw convergence to the 60 percent Stability and Growth Pact objective at a slower pace than in staff’s projections.

12. The authorities saw the risks to the outlook as generally balanced. On the upside, they noted that private investment could turn out stronger than expected and drive a more forceful recovery. On the downside, the authorities saw instability in the euro area as a result of renewed sovereign stress, possibly amplified by relatively low liquidity in some market segments, as the most relevant risk at the moment, though they noted that the system was now much more resilient than in the past. They also pointed out that heightened exchange rate volatility was a source of risk, and was seen as such by many German corporations.

Box 1.Impact on Germany of Slower Growth in Emerging Markets

Growth in emerging markets (EMs) was disappointing in the last two years and there is mounting evidence that a sizable part of the growth slowdown may have been structural (see World Economic Outlook, April 2015). Based on simulations using the Fund’s G20-MOD model, this box analyses the consequences on the German economy of a further slowdown in EMs (Brazil, China, India, Indonesia, Mexico, Russia, South Africa, and Turkey). In this scenario, the EM deceleration is due to a permanent decline in the level of total factor productivity (with respect to baseline) that is initially perceived as cyclical. As a result, EM monetary policy is loosened and currencies depreciate. As successive negative growth surprises occur, agents gradually become aware that the slowdown is in fact structural and the monetary loosening is gradually reversed.

Germany is among the most affected economies in the euro area under this scenario. Lower growth in EMs (GDP is 3 percent lower than in the baseline at the end of the fourth year) spills over to the global economy, including through a significant negative impact on commodity prices. Among Advanced Economies (AEs), the negative impact is the largest for Japan and the euro area given their trade exposures to EMs and their lack of (conventional) monetary policy space, though lower commodity prices help soften the blow somewhat. The drop in German GDP (-1.5 percent at the trough) is sizable and reflects Germany’s large exposure to EMs. The current account surplus is almost unaffected (-0.4 pp of GDP) as domestic demand and imports also drop. Lower exports translate into lower labor demand, higher unemployment, lower wages, lower inflation, and higher real interest rates (given the zero lower bound on nominal interest rates), which combined with lower growth prospects, income and wealth lead to a permanent decline in investment and consumption compared with the baseline. Moreover, looser monetary policy in EMs initially depreciates their currencies against the euro, which further impacts Germany’s competitiveness and weighs on exports. As EMs’ central banks gradually realize that the slowdown is structural, they start normalizing policy thereby progressively correcting domestic and external imbalances. Germany’s real exchange rate converges back to the baseline as does its current account, but the negative impact on consumption, investment and real GDP of the slowdown in EMs is much more persistent.

Emerging Markets


External Assessment

13. Germany’s external position is substantially stronger than implied by medium-term fundamentals and desirable policy settings.

  • The cyclically adjusted current account balance stood at 8.1 percent of GDP in 2014, while staff assesses the norm at 3–5 percent of GDP. Hence, the current account is 3–5 percentage points of GDP stronger than the value implied by fundamentals and desirable policies. While the EBA model attributes 0.6 percentage points of the current account gap to Germany’s fiscal policy gap and 0.9 percentage points to the fiscal policy gaps in other countries, 3 percentage points remain unexplained and may be due to factors not fully captured by the model.

  • The REER is assessed as undervalued by 5–15 percent in 2014. Applying standard trade elasticities to the current account gap yields a REER undervaluation of 7–12 percent, while the EBA REER level model suggests an undervaluation of 16 percent.

  • Developments as of May 2015, notably the lower energy prices and depreciated REER, point to a further strengthening of the external position. Preliminary estimations of EBA REER models based on projections point to a larger undervaluation in 2015 if the current depreciation of the euro is sustained. While the current account surplus is projected to expand in 2015, the current account gap may remain stable because the EBA model norm is projected to increase as well, partly reflecting the evolution of demographic factors.

14. Germany’s current account surplus has been associated with a weaker domestic demand than in typical large and sustained current account surplus episodes in advanced countries. Even though the size and the duration of Germany’s surplus so far are in line with those of a typical episode, the weakness of domestic demand and, especially, the relatively strong fiscal position stand out (see Selected Issues). Real exchange rate or terms of trade movements did not play a major role in Germany’s episode or elsewhere, with the exception of the ULC-based REER which depreciated in the run-up to and early years of the German episode. Exits from large and sustained current account surpluses, where they occurred, were typically accompanied by faster GDP growth—reflecting both higher potential growth and a stronger cyclical position.

Authorities’ Views

15. The authorities broadly agreed with the external sector assessment. While they emphasized the difficulty of identifying the ultimate drivers of the CA surplus, they praised the refinements and expansions of the EBA methodologies, particularly the more sophisticated treatment of demographic factors and the improved methods to explain cross-country differences in REERs. They noted that the methodological improvements reduced the size of the unexplained regression residual for Germany and gave a more reasonable model estimate of the equilibrium REER. They broadly agreed with the ESR assessment, though the Bundesbank saw the REER undervaluation at the lower bound of the staff’s range (around 5 percent for 2014).

Policy Discussions

With the economy in a favorable cyclical position underpinned by robust balance sheets and partly buoyed by short-term factors, progress is urgently needed on policies to strengthen growth in the medium and long term, while also generating much needed positive outward spillovers and reducing the large current account surplus.

A. Strengthening Both Growth Potential and Domestic Demand while Reducing External Imbalances

16. The working–age population is set to decline soon, which will put downward pressure on potential growth. For now, stronger immigration and a modest upward trend in labor market participation by female and older workers have compensated for the adverse effects of aging on the labor force (Box 2). However, this will become increasingly challenging as aging will accelerate. Also, currently high immigration flows may not be sustainable, and further increases in labor force participation by older workers may be difficult to achieve in the future, as suggested, for instance, by the government’s decision to lower the statutory retirement age for some categories of workers last year. Thus, if trend total factor productivity remains constant (as it has been in the recent past) and capital accumulation continues at its current modest pace, potential growth will decline rapidly after 2020.2 Muted prospects for long-term growth, in turn, may be holding back domestic private investment despite very favorable financial conditions and healthy corporate balance sheets; they might also help explain the large domestic savings-investment surplus in the corporate sector—a major contributing factor to the current account surplus.

Working-Age Population Projections

(Millions of people aged 15-74)

Sources: Federal Statistical Office’s 13th Coordinated Population Projection and IMF staff calculations.

17. In light of the continued weakness in global demand, stronger domestic demand in Germany, where balance sheets are healthy, would have important positive spillovers. Global demand remains weak as reflected by inflation below central banks’ targets across advanced countries and especially in the euro area, where the need to repair balance sheets in the private and public sector continues to weigh on the recovery in vulnerable countries.3 There is a concern that ever-looser monetary policy might be insufficient to bring about a lasting recovery, or that low interest rates for long might lead to financial instability.4 A host of policies are needed to address these problems, but stronger demand in Germany, where public and private balance sheets are sound, would be helpful. Stronger demand would also speed up adjustment in the current account surplus, reducing external imbalances.

Box 2.Potential Output in Germany

Re-estimating the trajectory of potential output in EU countries is particularly relevant at the current juncture, in light of the introduction of the ESA 2010 national accounts methodology as well as the need to reliably identify the permanent damage to potential output inflicted by the crisis (World Economic Outlook, Spring 2015). Staff, therefore, re-estimated potential output for three large euro area countries (France, Germany, Spain) using the new multivariate filter (MVF) developed by Blagrave et al. (2015). 1/2/ The MVF improves upon commonly used univariate filters (e.g., the HP filter) inter alia by modeling relationships between GDP, potential GDP, unemployment and inflation. Judgment based on information outside of the model can be incorporated to improve the plausibility of results.

In Germany, in contrast with other advanced countries, the scars left by the global financial crisis on potential GDP growth appear limited. The MVF suggests that potential GDP growth in 2011-14 was at the same level as in 2005-07. Furthermore, a decomposition of potential GDP growth shows that the same is true for total factor productivity (TFP) growth. However, the contribution of capital has been small since 2009, reflecting a downward level shift in investment during 2009-10. This has been compensated by a larger contribution of labor, reflecting several cross-currents: high immigration has momentarily put a brake on the previously negative contribution of working age population; in parallel, continuous increases in the labor force participation rate have more than offset the decline in average hours worked per employed; finally, the employment rate has kept increasing following the Hartz reforms (see Box 3).

Germany: Output Gap and Inflation, 1993-2020


Sources: Staff calculations

Germany: Potential Output Growth and Contributions, 1993-2020


Sources: Staff’s calculations based on MVF model with judgment

Note: TFP=total factor productivity

Under current policies, German potential GDP growth should remain stable around 1.3 percent over the next few years but start a secular decline at the end of the projection horizon. Given the lack of major ongoing structural reforms, stable R&D investment rates, and no acceleration in international TFP spillovers, TFP growth is expected to remain steady, while a modest investment recovery will gradually push up the contribution of capital. This will offset a smaller labor contribution driven by a deceleration of the labor force participation rate and of the employment rate. However, looking beyond 2020, the 13th demographic projections recently released by the Federal Statistical Office suggest that the decline in the working-age population will resume as immigration flows normalize and larger cohorts reach the age of 75, resulting in lower potential growth.

1/ See “Potential Output in France, Germany, and Spain: A Reassessment,” Chapter IV, Selected Issues for the 2015 Spain Article IV Consultation (forthcoming).2/ Blagrave P., R. Garcia-Saltos, D. Laxton, and F. Zhang (2015), “A Simple Multivariate Filter for Estimating Potential Output,” IMF Working Paper 2015/79.

18. Policies should therefore focus on fostering potential growth while generating positive demand spillovers. Using model simulations, last year’s staff report argued that increased spending on public investment in needed infrastructure, policies to reduce regulatory uncertainty regarding the energy transition, and reforms to increasing productivity in the nontradable services sector would lift potential output and generate meaningful positive outward spillovers to the rest of the euro area, while reducing the current account surplus. In particular, higher public and private investment (the latter brought about by energy sector reforms) were found to have especially large spillover multipliers.5

19. Policies that directly target higher wages may generate negative outward spillovers if they result in lower employment and weaker economic activity in Germany. The widening current account surplus in the mid-2000s coincided with labor market reforms that strengthened incentives for the unemployed to return to work. The reforms were accompanied by declining real wages and unit labor costs (Box 3). While real wages and unit labor costs began to rise in 2008 and the labor share is back to its long-term average, the current account surplus has not declined, raising the question of whether policies should try to achieve faster wage growth to foster external rebalancing. Model simulations indicate that policies that directly target wage increases (such as a social pact or measures to strengthen the negotiating power of workers) would lead to a REER appreciation and a modest fall in the current account surplus, but would also bring about reductions in employment and production in Germany as well as negative growth spillovers to the rest of the euro area (see Selected Issues). By contrast, wage increases resulting from positive demand shocks would be associated with higher output and employment and a lower current account surplus in Germany as well as positive growth and economic activity in the rest of the euro area.

Authorities’ Views

20. The authorities agree that population aging is a primary concern and would be comfortable with a lower current account surplus, but emphasized that the current account balance is not a specific policy goal. They shared concerns about declining long-term growth rates and lackluster private investment in spite of low interest rates, and were thus open to policies that might improve the corporate sector’s willingness to invest in Germany and, through that avenue, reduce the current account surplus. However, they rejected any notion of fiscal stimulus citing the closed output gap and limited outward spillovers. They also emphasized that in a monetary union, monetary policy—but not fiscal policy—should be set for the union as a whole. Overall, they were comfortable with current nominal and real wage growth, which they saw as reflecting the tightening labor market and bringing about the needed realignment of competitiveness within the euro area at an appropriate pace.

Box 3.The Hartz Labor Market Reforms 10 Years on

As other European countries, beginning in the mid-1970s Germany experienced an upward trend in the unemployment rate as increases in recessions were only partially reversed in expansions. In 2003-05, with unemployment at new highs, Germany embarked on a sweeping set of reforms (the Hartz reforms). The reforms eased regulation on temporary work agencies, relaxed firing restrictions, restructured the federal unemployment agency, significantly reduced benefits for long-term unemployed (which were high in international comparison), and tightened job search and acceptance obligations for benefit recipients. Following the reforms, the unemployment rate declined steadily and is now at its lowest level since reunification. Were the Hartz reforms a key factor in reducing structural unemployment or did other factors play a role?

Existing studies have argued that the reforms helped reduce unemployment and increased the efficiency of job search but lowered average wages and increased wage inequality. An alternative view is that the favorable labor market developments in Germany mainly reflected wage moderation induced by the competition from Eastern Europe. To shed further light on these questions, staff research (Niklas Engbom, Enrica Detragiache, Faezeh Raei, “The German Labor Market Reforms and Post-Unemployment Earnings,” IMF Working Paper, forthcoming) using data from a detailed administrative dataset compares the pre- and post-reform labor market experience of two groups of workers: those in stable employment and those re-entering from unemployment from short-term unemployment (displaced workers). The chart below plots the median earnings of the two groups (normalized so that the two series have the same average during the pre-reform years), and shows that after the reforms the earnings of displaced workers fell markedly while those of other workers remained flat. This suggests that displaced workers were more willing to accept lower paying jobs to exit from unemployment after the reforms. The same result is confirmed when tested in a rigorous regression framework, in which observable and unobservable worker characteristics and macroeconomic factors are controlled for. These findings suggest that the reforms succeeded in strengthening incentives to return to work, thereby contributing to the sharp reduction in unemployment observed in Germany since 2005. As they achieved this goal, however, they imposed a higher burden on workers experiencing unemployment in terms of reduced post-unemployment earnings.

Normalized Earnings of Workers in Stable Employed and Displaced Workers

Note: Log monthly real labor income (12-month moving average). Full-time employed males age 25-62. Displaced workers had spent at least three years in continuous full-time employment prior to unemployment, transited from a full-time job to unemployment at some point 12 months ago and are currently full-time employed. Non-displaced workers have spent at least four years in full-time employment. The vertical bars denote the period of the Hartz reforms.

Source: Sample of Integrated Labor Market Biographies (SIAB).

B. Public Investment

21. The government stepped up initiatives to boost public investment, although there is scope for more ambitious action. Last year, the Fund called for a 2 percent increase in investment in infrastructure over four years to address needs identified by expert studies. The federal government recently announced plans to raise public investment. These include 0.1 percent of GDP allocated to a new infrastructure fund for financially weaker municipalities in 2015 (plus a new allocation of about ½ this year’s size for 2017) as well as new spending mostly in public transportation, the digital infrastructure, and energy efficiency improvements totaling 0.4 percent of GDP over 2016–18. All in all, the 2015 German Stability Program foresees the general government public capital spending to increase on average by 4.6 percent per year during 2015–19, against an average growth rate of 1.7 percent in 2011–14, and going from 2.2 percent of GDP in 2014 to 2.3 percent of GDP in 2019. A further boost to public investment is expected to come from financial relief granted to municipalities, although this effect cannot be quantified yet. Additional increments in infrastructure spending outside the general government (for instance, by public enterprises or private-public partnerships) may also be forthcoming. Overall, however, the new plans appear to be well short of last year’s Fund advice. Delivering on the reminder of the proposed increase would be desirable. If fully financed through the budget, and implemented during the current legislature, such a program would utilize most of the fiscal space available under the MTO, bringing the general government structural balance down to -0.3 percent of GDP by 2017 (Figure 4). The medium-term fiscal position, however, would remain well anchored. The additional investment expenditure would also complement ongoing centralized investment initiatives at the European level, such as the European Fund for Strategic Investment (Juncker Plan).

22. To facilitate ratcheting up public investment, new initiatives to improve the planning process at the local level and facilitate public private partnerships (PPPs) would be useful. A third of public investment is executed at the municipal level. Stretched public finances in some regions have constrained investment budgets in the past and will likely continue to do so in the medium term, as regions need to reach zero structural balance by 2020. In addition, at the federal and general government level mounting aging costs and a normalization of real interest rates are likely to make meeting the fiscal rules in the future more challenging than at present, possibly putting renewed pressure on public investment budgets. Hence, alternative financing mechanisms such as PPPs may be useful to boost public investment now and help ensure adequate investment levels in the future. However, as local authorities may have limited expertise to contract with the private sector, and the planning process for infrastructure is seen as fragmented and less efficient than at the federal level, the creation of a coordinating agency could be particularly beneficial (see Selected Issues). Such an agency would advise on contract design, help improve information transparency, and inform the public debate on project selection by highlighting fiscal risks and cross-project externalities. In addition, sector-specific infrastructure companies, as proposed by the Expert Commission on “Increasing Investment in Germany,” would be helpful as long as the associated fiscal risks are appropriately managed, either by a transfer of project risks to the private sector or by including the companies in the general government perimeter.

Authorities’ Views

23. The authorities noted that public investment had been stepped up substantially by the government and underlined the need to maintain buffers under the fiscal rule. The Ministry of Finance viewed the new initiatives of the current government as a substantial investment expansion package, and did not see merit in further increases also in light of other priorities, such as income tax relief after years of “bracket creep.” It also stressed the need to maintain some margins under the fiscal rules in case of adverse budgetary surprises and the benefit of having a budgetary anchor, such as a balanced federal budget, which can be easily explained to the public. The Ministry agreed that a coordinating agency could help mobilize investment at the local level, but pointed out that creating such an agency would take time (hence the importance of support from federal transfers in the short run), and it may prove challenging given the German federal framework.

C. Structural Reforms: Services Sector and Energy

24. Competition-enhancing reforms in the services sector are very slow to materialize. Labor productivity growth in the services sector remains low, particularly in business services. Barriers to competition have been documented by the OECD and the Monopolies Commission in several large sub-sectors, and their removal would boost productivity and potential growth. 6 Germany’s leadership in this area would also likely help catalyze reforms in other European Union members. In the area of the regulated professions, the European Commission (EC)-led transparency and mutual evaluation exercise—focused on access conditions—will be completed in January 2016 and no conclusions have been drawn yet. The government has initiated a review of the restrictions on equity investment in the field of selected professions (e.g., architects and engineering companies) and results are expected by the end of the year. Regarding price regulation, the EC initiated pilot proceedings against Germany last December, inter alia posing questions with respect to the scale of fees of some professions. It is yet unclear whether this procedure will lead to any significant change. In the area of rail transportation, a new draft of the regulation law is being discussed, which is a not-to-be-missed opportunity to enhance regulatory powers to limit discriminatory practices by the incumbent operator and thus promote greater competition in all business segments.

Sectoral Labor Productivity Growth and Share of Total Gross Value Added


Sources: Federal Statistical Office and IMF staff calculations.

25. On the energy front, progress is being made to tackle the challenges from the ambitious program of transition to renewable sources and nuclear phase-out, but several issues remain. The Renewable Energy Act was amended last year to help contain costs for retail electricity users, while the EC decided to allow the continuation of subsidies for large companies competing internationally at least until 2020. However, this controversial subsidy, which is paid for by higher electricity charges on other users, remains uncertain in the long run; also, key decisions are still pending on how to secure conventional back-up capacity as renewable capacity is expanded. A still unresolved issue is how grid expansion can be expedited amid strong opposition by affected parties in some regions. These challenges should be addressed rapidly to ensure that electricity costs, already among the highest in Europe, do not continue to climb, and to remove important elements of uncertainty in private sector investment decisions.

Authorities’ Views

26. The authorities were confident that the energy transition would be successfully managed and acknowledged that progress in the area of professional services was slow. On the energy agenda, they noted that, after many years of rapid growth, in 2015 the electricity price surcharge related to renewable sources had not increased—though this reflected in part statistical factors. They indicated that plans to auction off renewable subsidies would introduce more competition and help curb costs. In the services sector, they indicated that work to identify growth-enhancing product market competition policy measures was ongoing. More specifically, on regulated professions they agreed that there was scope for re-assessing the relevance of parts of the regulation, but noted that political support for these reforms was generally weak and that they required a case-by-case review to ensure that quality standards in the provision of services would not be compromised.

D. Countering Adverse Demographics: Female Labor Force Participation

27. To counter the adverse effect of population aging on labor supply, stronger policies to spur female labor force participation are needed. Although female labor force participation is relatively high in Germany (above 70 percent), about half of working women work part time (in part because women are the main holders of so-called mini-jobs), a pattern which is often attributed to an insufficient supply of good quality child care services and afterschool programs, as well as disincentives from the tax-benefit system (see Selected Issues). Closing this gap could help stem the projected decline in the labor force over the coming decades. Staff estimates that if the difference in average hours worked by men and women were fully closed, potential output would increase by as much as 7.5 percent. The federal government has recognized this as a priority and increased investment in the expansion of child care facilities by 0.1 percent of GDP in total over the last three years. However, faster progress in this area, for instance by making a comparable investment in the expansion of after school programs, is essential to broaden opportunities for women in the labor market. This would also help reduce poverty among single mothers. In addition, reforms to the tax-benefit system aimed at encouraging full-time work would also be beneficial. These could include lowering the tax wedge for secondary earners by moving closer to a system of individual taxation, reducing differences in the health-insurance premiums for working and non-working spouses, and targeting cash support for non-working parents to poorer households. Addressing both types of constraint simultaneously should allow for a more effective response of female labor supply.

Selected Labor Force Indicators by Gender, 2014

Source: Eurostat.

Authorities’ Views

28. The authorities stressed progress under way on female labor force participation. They pointed out that female labor force participation in Germany is one of the highest among advanced economies, while the prevalence of part-time work partly reflects social preferences. Although they agreed that fiscal disincentives for secondary earners were high—in particular free health care coverage of spouses not working or working in a mini-job—they noted that the absence of widespread provision of high quality child care and afterschool programs was likely to be a more important constraint to full-time employment. In that context, they highlighted progress made in these areas over recent years, notably increased child care supply.

E. Monetary and Financial Sector Policies

29. Although QE is expected to be very beneficial for the euro area recovery, its perception by the German public is generally negative. A long-standing preference for low inflation and a relatively favorable cyclical position contribute to a concern that current monetary conditions may become too accommodative from a German perspective, a development that does not feature in staff’s baseline macroeconomic scenario and is not seen as a significant risk by staff. In addition, German households hold a large share of their wealth in nontradable fixed income assets such as bank deposits and life insurance policies, typical mortgages have a fixed interest rate, and the rate of home ownership is low relative to other advanced countries.7 Thus, in Germany lower interest rates and higher asset prices following QE do not translate into stronger household balance sheets as much as in other advanced countries.

Selected Advanced Economies: Composition of Household Financial Assets

(Percent of total financial assets, 2013)

Sources: Haver Analytics and IMF staff calculations.

30. The moderate upward trend in housing prices continues and the appropriate response at this stage is close monitoring and readying the macroprudential toolkit. After years of stagnation, nominal housing prices at the aggregate level have grown at an annual pace of 3–4 percent for the past five years—only marginally faster than the growth in disposable income. In spite of falling lending rates, mortgage loan growth remains modest and lending standards appear stable. Thus, there are no signs of overheating yet. Nonetheless, developments in the most dynamic segments, such as apartments in large cities, deserve particular supervisory attention, and efforts to step up data collection on mortgage loan terms and conditions need to continue, including because of a significant share of high reported loan-to-value ratios (LTVs) in those segments in a recent Bundesbank survey. Last December, the Financial Stability Committee (FSC) announced that it was examining an expansion of the German macroprudential toolkit, as recommended by the FSB and the Fund last year. Introducing instruments constraining mortgage loan eligibility, such as loan-to-value and debt-service-to-income limits, would be very helpful, not only because they might be needed in the future, but also because of the signaling value of this policy decision. A carefully designed communication strategy would help make the most of this signaling value.

31. In the banking sector, large banks’ continued momentum to build up their capital position post SSM Comprehensive Assessment is welcome. Germany’s globally systemically important bank recently announced a new strategic plan whereby it will target a leverage ratio of 5 percent—a significant increase compared to the current level—bringing it more in line with its international peers. Germany’s second largest bank recently completed a capital increase that will also bring its capital ratios closer to its European peers. Most other large domestically owned banks, which cannot rely on markets to raise fresh equity because of their corporate structure, are expected to keep building capital buffers through profit retention and/or continued refocusing on their German core business. A strong capital position is especially important in light of banks’ low profitability. Depending on the bank, the latter reflects a combination of remaining crisis legacy problems (especially among banks under state aid procedures), litigation costs (in the two largest banks), the need to adjust business models to the post-crisis regulatory environment (in all large banks), as well as low interest margins (in the banking sector as a whole). The reform of the Landesbanken, which are particularly exposed to some of these challenges, is still under way, although deleveraging is slowing as non-core legacy portfolios have already shrunk significantly and selective new business is being underwritten.

Domestic Banks: Net Interest Margin


Source: European Central Bank.

Domestic Banks: Return on Assets


32. Close monitoring of the effects of the low interest rate environment on the banking sector is appropriate. Net interest margins remain under pressure and well below those of European peers, and banks are reluctant to charge fees to retail customers. A recent Bundesbank study suggests that banks are increasing term transformation, exposing them to more interest rate risk. To better assess this risk, German supervisors have recently asked banks that are not directly supervised by the ECB to run bottom-up stress tests over five-year horizons under various yield curve assumptions. Further consolidation to cut costs, especially among the large number of small retail-focused institutions, would seem a natural response to the current environment but appears to keep proceeding only slowly.

33. The German banking sector is adjusting to the new European supervisory and regulatory landscape. ECB staff now coordinates with German supervisory bodies within the framework of the SSM. Work is ongoing within the SSM to improve the consistency of supervisory practices across countries and develop a common supervisory culture. Supervisory priorities this year include a review of business models, governance, and capital adequacy. Initiatives are ongoing to harmonize options and national discretions set out in the European capital regulation and directive, while a process to implement a resource-intensive review of banks’ internal models is being set-up. The Bank Recovery and Resolution Directive (BRRD) has been transposed and its bail-in regulation is in force since January 2015, one year ahead of the EU schedule. The harmonization of the Deposit Guarantee Schemes through the 2014 European Directive is forcing the cooperative banks and savings banks (together with the Landesbanken) to reform their respective joint protection schemes, so that they can be included in deposit guarantee schemes and recognized as statutory schemes. The forthcoming FSAP will be an opportunity to take stock of these transformations.

34. Although a breach of regulatory requirements is not immediately in sight, life insurers still face solvency challenges over the medium term that need to be addressed by ensuring that adequate capital buffers are maintained. The German life insurance sector is particularly vulnerable to a prolonged low interest rate environment as investment income may not be sufficient to meet returns guaranteed to policyholders over the medium-to-long term.8 This challenge will only be made more salient by the soon-to-begin transition to the Solvency II regulatory framework.9 The Life Insurance Reform Act passed in July last year included a reduced obligation to share unrealized gains with policyholders upon expiry of their contract, strict restrictions on dividend payments, and a reduction of the minimum guaranteed rate on new contracts. The Act is expected to have significantly positive effects on the sector’s solvency, according to Bundesbank simulations. 10 However, the fall in yields since the reform was calibrated has made the underlying problem on the stock of existing contracts more challenging. Insurers have reacted mostly by reinvesting into longer duration, higher yielding assets, but this may not be enough and further protection of capital buffers is needed. Thus, vulnerable insurers should manage their profit participation with policyholders very prudently, and the new early intervention powers granted to supervisors by the reform last year should be used to ensure that this is the case. As standard guaranteed rates products still represent about 80 percent of the flow of new contracts, the industry as a whole would also benefit from the greater promotion of new products, such as unit-linked products, which embed much less interest rate risk.

Authorities’ Views

35. The authorities agreed that risks associated with the low interest rate environment in Germany and other advanced economies should be closely monitored. They explained that households displayed strong liquidity preference and risk aversion, which was visible from the growing share of highly liquid deposits in their portfolios since 2008; by contrast, non-bank financial intermediaries showed a certain appetite for yield. They anticipated that the FSC would soon follow up on its announcement made last December that it was reviewing the appropriateness of the current macroprudential toolkit, in particular its ability to fully address possible financial stability concerns in the housing market. They also explained that the FSC strategy document published last year addressed a number of the 2014 FSB Peer Review recommendations, and that work on improving mortgage market databases was ongoing at the Bundesbank. Regarding the domestic life insurance sector, while acknowledging the extent of the challenge for the industry, Bafin emphasized that Germany had been proactive in its policy response over the past few years and recalled the introduction of the so-called interest rate reserve as early as 2011.

36. The authorities emphasized the progress in building stronger capital buffers over the past several years and cautioned about too much harmonization of the capital framework within the SSM. While recognizing that large German banks still had room to catch-up with their European peers in terms of leverage ratio, they emphasized the continued capital building dynamics. They expressed their appreciation for the general goal of harmonizing regulatory policy within the SSM, but noted that the underlying reasons for national options and discretions needed to be examined, as in some cases they might be justified. They also reiterated their position that it would be reasonable to abolish zero risk-weighting and apply a large exposures regime to sovereign bonds, as evidenced by the current experience with the resolution of state-owned Heta (Austria). In the area of bank recovery and resolution, they expected the European Banking Authority to publish technical standards on the minimum requirement for own funds and eligible liabilities (MREL) later this year, and explained that a draft German law currently under discussion would make senior unsecured (tradable) securities subordinated to the bank’s other senior unsecured (non-tradable) liabilities in insolvency so as to provide greater legal certainty.

Staff Appraisal

37. The upturn is expected to continue in 2015, with growth lifted by the double stimulus of low energy prices and QE. Private consumption should be the largest contributor to growth, underpinned by a strong increase in real disposable income. Inflation should remain subdued in the medium term, consistent with an output gap close to zero. A further decline in the historically low unemployment rate and sound wage growth point to a tightening of the labor market. Growth could be higher than forecast if the transmission of lower energy prices and QE proves more powerful than expected. Notable downside risks include weaker-than-expected growth in trading partners, or renewed stress in the euro area triggered by policy uncertainty or faltering reforms in some countries.

38. Lower interest rates and the strong labor market will continue to support the fiscal position. For the remainder of this legislature, budget plans are anchored on a zero balance at the federal level with small surpluses for the general government, on the back of buoyant revenues. Staff expects larger fiscal surpluses than the authorities, mostly on account of lower projected interest payments, which would bring public debt below 60 percent of GDP by 2020. The structural fiscal balance should decline through 2015–17, while remaining comfortably above the Medium-Term Objective of the Stability and Growth Pact.

39. The external position remains substantially stronger than implied by medium-term fundamentals and desirable policy settings. The fall in energy prices and the exchange rate depreciation will boost the already large current account surplus. We project the surplus to exceed 8 percent of GDP this year and decline slowly in the medium term, as the energy price windfall is gradually spent and macroeconomic rebalancing in Germany and within the euro area strengthens. Recent solid wage and unit labor cost increases (against the background of rising employment) are welcome in this regard, as they facilitate this process. Nevertheless, the persistently large current account surplus is a source of concern in the current context of weak demand across advanced countries in spite of ultra-expansionary monetary policies. It may also reflect reluctance by the corporate sector to invest more in Germany, which hurts future growth prospects.

40. Commitments to boost public investment should be more ambitious. During the last consultation, the Fund recommended a public investment increase of some 2 percent of GDP over four years to address needs identified by expert studies. Such a program would stimulate private investment by removing infrastructure bottlenecks, thereby strengthening future growth potential. It would also support domestic demand in the short-to-medium run, help reduce the current account surplus, and generate positive spillovers to the rest of the euro area. While recently announced plans to expand public investment target important priorities, they do not fully address existing needs and a stronger effort would be warranted. This expenditure could be accommodated under the existing fiscal rules. In addition to infrastructure, the Energy Transition remains a source of regulatory uncertainty and high electricity costs for parts of the corporate sector, which should continue to be addressed so as to improve the investment climate.

41. Infrastructure investment can benefit from initiatives to improve planning processes and take advantage of private sector expertise. For instance, sector-specific infrastructure companies, as proposed by the Expert Commission on “Increasing Investment in Germany,” would be helpful, as long as the associated fiscal risks are appropriately managed, either by a transfer of project risks to the private sector or by including the company in the general government perimeter. To boost investment at the municipal level, staff supports the use of alternative financing/execution mechanisms, such as public-private partnerships. However, as local authorities may have limited expertise to contract with the private sector, and the planning process for infrastructure is seen as fragmented and less efficient than at the federal level, the creation of a coordinating agency could be explored. Such an agency would advise on contract design and inform the public debate on project selection by centralizing information, enhancing transparency, and highlighting fiscal risks and cross-project externalities.

42. With the prospect of a declining working–age population putting downward pressure on future growth, reducing existing disincentives for women to work full time is necessary. Although female labor force participation is relatively high, about half of working women work only part time. While this may reflect individual and social preferences, the tax-benefit system likely discourages labor supply, given the high overall marginal tax burden faced by secondary earners. In addition, provision of additional and higher quality child care services and after-school programs could facilitate the choices of working parents. Faster progress in these areas is essential to broaden opportunities for women in the labor market. It may also help address bottlenecks in the availability of qualified labor, which may be holding back private investment. In this regard, reviewing policies that favor early retirement would also be important.

43. Fostering a more dynamic services sector through greater competition should be high on the structural reform agenda. While a strong manufacturing sector has been the backbone of the German economy, sluggish productivity growth in services may hinder future potential growth as this sector continues to expand in relative size. Germany’s leadership in this area would also likely help catalyze reforms in other EU members. In the area of regulated professions, the ongoing transparency exercise led by the EC is an opportunity to review which parts of the existing regulations are too restrictive. Pilot proceedings recently initiated by the EC against Germany regarding price regulation in some professions (architects, engineers, and tax advisors) might lead to some welcome relaxation. In rail transportation, reinforcing the regulator’s powers to stop discrimination against the incumbent operator’s competitors should be a key objective of the new regulation law being prepared.

44. In the financial sector, the new European bank supervisory and regulatory landscape is taking shape, while the favorable domestic macroeconomic conditions support structurally weak bank profitability. Banks are now supervised by the SSM, recovery and resolution planning is progressing, and safety nets are being strengthened in line with European directives and regulations. As long-term lending interest rates have fallen further, structurally low profitability is under greater pressure, and banks will have to address it by reducing costs or stepping up fee-based activities. However, the continued good performance of domestic loan portfolios has been partially offsetting these pressures through lower loan loss provisions.

45. Steps recently taken by large banks to improve their capital position are welcome. The SSM’s Comprehensive Assessment last year revealed rather modest additional provisioning needs for large banks. However, the stress test showed that some capital buffers were thin when capital adequacy was measured on the basis of the fully implemented new European standards. In addition, leverage remains high in some banks. Against this background, Germany’s two largest banks’ recent measures to catch up with their international peers are reassuring. Nevertheless, profitability challenges remain beyond those related to the low interest environment and, depending on the bank, reflect various combinations of persistent crisis legacy issues, litigation costs, as well as the need to adjust the business model to the post-crisis regulatory environment. Close cooperation and coordination within SSM joint supervisory teams is particularly important in this context.

46. A moderate upward trend in housing prices continues and the appropriate response at this stage remains close monitoring and readying the macroprudential toolkit. There are no signs of overheating at the aggregate level and mortgage loan growth remains modest. Nonetheless, developments in hot spots bear monitoring, and efforts to step up data collection on mortgage loan terms and conditions need to continue, including in light of the significant share of loans with high loan-to-value ratios in segments of the market as revealed in a recent Bundesbank survey. Staff continues to recommend that instruments constraining mortgage loan eligibility, such as loan-to-value and debt-service-to-income limits be introduced in the macroprudential toolkit. The publication by the Financial Stability Committee of a strategy document is welcome.

47. Further actions need to be taken to tackle vulnerabilities in the life insurance sector in spite of the beneficial effects of the reform passed last year. The life insurance sector is particularly vulnerable to a prolonged low interest rate environment as investment income may not be sufficient to meet returns guaranteed to policyholders over the medium-to-long term. This challenge will only be made more salient by the transition to the new Solvency II regulatory framework set to begin next year. The 2014 life insurance reform, which includes a reduced obligation to share unrealized gains with policyholders upon lapsing of their contract, is expected to have significantly positive effects on the sector’s solvency according to Bundesbank simulations. However, the fall in yields since last summer requires that the industry exert great prudence in the management of profit participation with policyholders and promote new products that embed much more limited interest rate guarantees. In parallel, supervisors should make full use of the additional early intervention powers granted to them by the new law to ensure prudent behavior.

48. It is recommended that the next Article IV consultation take place on the regular 12-month cycle.

Table 3.Germany: Medium-Term Projections, 2012-20
(Percentage change unless otherwise indicated)
Real sector
Real GDP0.
Total domestic demand−
Foreign balance (contribution to growth)1.4−−0.1−0.1
Output gap (percent of potential GDP)0.4−0.6−
Consumer prices2.
(Percent of GDP)
External sector
Current account balance6.
Goods and services balance5.
General government
Overall balance0.
Gross debt79.377.174.770.667.965.362.659.657.0
Sources: Federal Statistical Office, Bundesbank, and IMF staff estimates.
Table 4.Germany: Balance of Payments, 2012–20(Percent of GDP)
Current account6.
Trade balance5.
Trade in goods7.
Trade in services−1.3−1.6−1.3−0.9−1.0−1.1−1.1−1.1−1.2
Income balance2.
Current transfers−1.5−1.5−1.3−1.3−1.3−1.3−1.3−1.3−1.3
Capital and Financial Account5.
Capital account0.
Financial account5.
Direct Investment1.
Portfolio investment balance2.
Financial derivatives0.
Other financial transactions1.
Change in reserve assets0.00.0−
Net errors and omissions−
Sources: Bundesbank, Federal Statistical Office, IMF Statistics Department, and IMF staff estimates.
Table 5.Germany: International Investment Position, 2006-14(Percent of GDP)
Direct investment41.244.938.846.947.845.
Portfolio investment75.576.357.173.374.863.478.182.679.7
Equity and investment fund shares29.527.715.720.721.617.221.124.624.3
Debt securities46.148.641.452.653.146.156.958.055.3
Financial derivatives (other than reserves) and employee stock options30.731.635.223.024.7
Other investment86.496.489.095.396.189.597.489.279.1
Reserve assets3.
Direct investment34.336.230.235.435.433.340.642.236.7
Portfolio investment83.695.878.393.392.785.599.895.788.1
Equity and investment fund shares20.826.412.518.919.515.119.822.919.7
Debt securities62.869.365.874.473.270.580.072.868.4
Financial derivatives (other than reserves) and employee stock options30.732.035.422.925.7
Other investment60.662.
Net International Investment Position28.327.522.
Direct investment6.98.78.611.512.411.813.413.014.8
Portfolio investment−8.1−19.5−21.3−20.0−18.0−22.2−21.7−13.0−8.4
Financial derivatives (other than reserves) and employee stock options−0.1−0.5−0.20.1−1.0
Other investment25.834.331.034.330.331.125.625.322.9
Sources:IMF Statistics Department and IMF staff calculations.Note: Based on Balance of Payments Manual 6.
Table 6.Germany: Core Financial Soundness Indicators for Banks(In percent)
Capital adequacy
Regulatory capital to risk-weighted assets14.816.116.417.919.218.0
Commercial banks14.915.415.617.818.917.2
Savings banks14.715.115.815.916.416.6
Credit cooperatives14.014.715.615.816.617.4
Regulatory Tier I capital to risk-weighted assets10.811.812.114.215.615.4
Commercial banks12.112.913.
Savings banks9.79.910.512.513.414.5
Credit cooperatives9.59.810.411.112.013.5
Asset composition and quality
Sectoral distribution of loans to total loans
Loan to households26.326.226.226.828.528.7
Commercial banks23.222.321.420.822.922.3
Savings banks57.657.756.257.257.457.0
Credit cooperatives66.467.066.868.769.369.8
Loans to non-financial corporations14.814.614.614.915.615.2
Commercial banks12.912.111.911.512.312.0
Savings banks19.620.120.321.522.021.7
Credit cooperatives13.614.314.
NPLs to gross loans3.
Commercial banks2.
Savings banks4.
Credit cooperatives4.
NPLs net of provisions to capital36.934.231.627.423.8
Commercial banks29.820.419.116.413.3
Savings banks39.636.235.331.527.6
Credit cooperatives42.
Source: Deutsche Bundesbank. The authorities provide annual data only and disseminate them once a year.
Earnings and profitability
Return on average assets (after-tax)−
Commercial banks−
Savings banks0.
Credit cooperatives0.
Return on average equity (after-tax)−
Commercial banks−
Savings banks4.
Credit cooperatives5.18.011.911.511.0
Interest margin to gross income72.573.272.971.571.9
Commercial banks6362.759.861.863.0
Savings banks78.679.179.679.480.0
Credit cooperatives76.978.978.078.278.6
Trading income to gross income4.
Commercial banks9.
Savings banks0.2−
Credit cooperatives0.
Noninterest expenses to gross income65.163.763.964.269.1
Commercial banks73.572.567.967.272.8
Savings banks66.662.862.765.767.2
Credit cooperatives68.363.763.965.964.6
Liquid assets to total short-term liabilities144.1137.0137.9144.2140.5145.5
Commercial banks131.1126.2124.3129.5125.1128.3
Savings banks225.7216.2210.1233.6234.6238.9
Credit cooperatives204.2203.8208.4230.6231.8233.3
Sensitivity to market risk
Net open positions in FX to capital5.
Commercial banks3.
Savings banks9.
Credit cooperatives7.
Source: Deutsche Bundesbank. The authorities provide annual data only and disseminate them once a year.
Table 7.Germany: Additional Financial Soundness Indicators(In percent, unless otherwise indicated)
Deposit-taking institutions
Capital to assets4.
Commercial banks5.
Savings banks5.
Credit cooperatives5.
Geographical distribution of loans to total loans
EU-member countries19.517.616.816.016.015.8
FX loans to total loans11.511.511.010.510.011.5
Personnel expenses to noninterest expenses54.752.752.052.951.9
Commercial banks49.446.345.546.644.7
Savings banks62.461.961.762.762.3
Credit cooperatives61.960.559.759.659.8
Trading and fee income to total income27.526.827.128.528.1
Commercial banks37.037.340.238.237.0
Savings banks21.420.920.420.620.0
Credit cooperatives23.
Customer deposits to total (non-interbank) loans76.573.673.675.784.586.9
Commercial banks89.785.083.184.0104.5109.2
Savings banks109.9106.9106.9107.7108.5110.0
Credit cooperatives122.7119.0117.7118.7116.9117.5
Deposits/total assets67.360.860.061.364.663.9
Commercial banks77.258.658.060.365.663.3
Savings banks86.886.786.786.886.786.7
Credit cooperatives85.485.986.386.686.887.0
Interbank assets/total assets41.335.034.834.335.033.9
Commercial banks43.232.632.734.135.934.8
Savings banks26.925.324.922.721.220.3
Credit cooperatives29.928.
Interbank liabilities/total assets26.723.421.821.721.521.7
Commercial banks32.224.222.523.622.623.6
Savings banks18.817.416.615.514.113.1
Credit cooperatives15.514.114.314.213.213.1
Securitized funding/total assets
Commercial banks
Savings banks
Credit cooperatives
Commercial banks38.527.527.327.230.028.1
Savings banks59.960.961.762.963.763.9
Credit cooperatives56.557.458.259.060.661.2
Securities holdings/assets23.519.518.118.019.419.0
Commercial banks19.212.611.
Savings banks26.826.625.025.425.225.2
Credit cooperatives27.527.526.627.827.427.8
Off-balance sheet operations to total assets
of which: interest rate contracts
of which: FX contracts
Spread between highest and lowest interbank rates 1/15.012.814.411.03.04.1
Spread between reference loan and deposit rates 2/342.0343.0324.0326.0319.0
Source: Deutsche Bundesbank. The authorities provide annual data only and disseminate them once a year.
Insurance sector
Solvency ratio, Life186.2180.8177.0169.0162.0
Solvency ratio, Non-life (w/o reinsurance and health insurance)290.0314.0312.0314.0317.0
Return on average equity, Life 3/
Return on average equity, Non-life (w/o reinsurance and health insurance) 3/
Market liquidity
Average bid-ask spread in the securities market (government bills)
Average bid-ask spread in the securities market (corporate securities)
Corporate sector
Total debt to equity108.793.5102.791.585.984.6
Total debt to GDP 4/146.1133.7128.9129.6131.1129.9
Return on invested capital 5/6/
Earnings to interest and principal expenses 7/935.81021.31233.41304.01339.61467.9
Number of applications for protection from creditors 8/161671528314553139511434413480
Household debt to GDP64.662.059.856.255.1
Household debt service and principal payments to income 7/
Real estate markets
Real estate prices, new dwellings 9/96.5100.0106.3111.6114.5120.7
Real estate prices, resale 9/97.9100.0105.0111.0114.7120.6
Real estate prices, new and resale 9/97.4100.0105.4111.2114.7120.6
Real estate prices, commercial property 10/97.1100.0104.8109.9117.4
Residential real estate loans to total loans16.916.816.717.118.319.0
Commercial real estate loans to total loans5.
Source: Deutsche Bundesbank. The authorities provide annual data only and disseminate them once a year.
Appendix I. Risk Assessment Matrix
Source of RisksRelative LikelihoodImpactPolicy response
Risks to the economic outlook
I. Slowdown of external demand, including because of protracted slower growth in key advanced and emerging economies or negative growth surprises in China. With its high degree of trade openness, Germany is especially susceptible to fluctuations in global demand.MMIf the output gap widens significantly, depending on the size and nature of the shock to the economy, invoking the escape clause under the fiscal rule could be appropriate to support German growth.
II. Reassessment of regional sovereign risk. Financial stress in the euro area could re-emerge triggered by policy uncertainty, faltering reforms, or political unrest.MM
III. Energy prices volatility. Uncertainty about the persistence of the oil supply shock and the underlying drivers of the price decline could undo part of the recent improvement in consumer and business confidence.HL
IV. Geopolitical tensions surrounding Ukraine (which could lead to disruptions in trade and financial and energy markets). In particular, Germany is exposed to an escalation of trade sanctions with Russia given its heavy dependence on Russian gas (40 percent of total consumption).MMRevisiting Germany’s energy strategy may become necessary.
Risks to the financial sector
Medium-term risks
V. Excessive risk-taking associated with the low interest rate environment. The recent strength in pockets of the German housing market could spread nationwide and real estate assets could become overvalued. Faced with falling net interest margin banks may be tempted to adopt (risky) search-for-yield strategies.LMTake precautionary measures now by strengthening the macroprudential framework and bank supervision. Keep pushing large banks to reduce their high leverage.
VI. Life insurance In a context of persistently low interest rates, some life insurers may not be able to pay guaranteed yields to policyholders and may become distressed. The shortfall would likely remain a very small share of GDP but may have a negative reputational impact on the financial sector as a whole.MLSupervisors should make full use of the additional early intervention powers granted to them by the 2014 life insurance reform law to ensure prudent behavior by the industry.
Appendix II. Authorities’ Response to Past IMF Policy Recommendations
IMF 2014 Article IV RecommendationsAuthorities’ Response
Fiscal Policy
  • Increase public investment in infrastructure by 2 percent of GDP over four years especially in areas that enhance growth potential (e.g., transport).

  • Plans for additional public investment of some €17 billion (0.6 percent of GDP) have been announced so far taking advantage of a better-than-expected fiscal position.

Financial Sector Policy
  • Banks should keep strengthening their capital position ahead of the completion of the ECB’s Comprehensive Assessment.

  • The macroprudential framework needs to be ready as monetary conditions are set to remain accommodative for a prolonged period.

  • Take measures to address solvency risk in medium-sized life insurance companies

  • Banks’ capital ratios have improved, and the largest banks have raised fresh equity (before or after the Comprehensive Assessment). Only a relatively small German bank had a capital shortfall.

  • The Financial Stability Committee has published a document explaining its strategy. It is currently examining what specific instruments to add to the existing toolkit. Based on this examination, the Committee may make a recommendation to the federal government.

  • The July 2014 Life Insurance Reform Act helps strengthen the sector’s solvency, but a further decline in interest rates since then has exacerbated the underlying problem posed by interest rate guarantees.

  • (For progress on the implementation of outstanding FSAP recommendations see Annex II)

Structural Reforms
  • Reforms in services sector regulation would boost competition and productivity.

  • Greater clarity about the future energy sector regulatory framework would encourage private investment in the energy infrastructure and beyond and strengthen the outlook.

  • No significant competition-enhancing reform has taken place in the services sector. The EC-led transparency and mutual evaluation of regulated professions exercise will be finished in January 2016. No conclusions have been drawn yet. The government has initiated a review of the shareholding rules of selected regulated professions.

  • In 2014 Parliament approved a revision of the Renewable Energy Sources Act, which aims at containing cost increases for electricity users and reduce uncertainties. A Green Paper to elicit views on how to balance renewable and conventional electrical capacity has been issued as a first step toward future legislation.

Appendix III. Main Outstanding 2011 FSAP Update Recommendations
Continue improving stress testing in the banking and insurance sectors. Rigorously ensure that any institution that displays weaknesses on a forward looking basis strengthens its balance sheet and takes managerial action.In 2014, 24 large banking groups (21 SSM banks and 3 banking groups later deemed as “less significant”) participated in the 2014 Comprehensive Assessment/EBA EU-wide stress test that covered all relevant risk factors except conduct risks, while also reflecting adjustments from an asset quality review. Moreover, in addition to the macroeconomic top-down stress test which has been significantly revised (more elaborated econometric techniques, inclusion of second-round effects), the Bundesbank recently initiated a bottom-up exercise that addresses the profitability of banks in a low-interest rate environment. This survey covers the banks’ projected income under their target assumptions and different interest rate scenarios, as well as credit spread and credit risk stress test components. Regarding the insurance sector, the Bundesbank applied a top-down scenario analysis to assess the impact of the 2014 German Life Insurance Reform Act on both the solvency of life insurance companies and financial stability. Furthermore, in 2014 the Bundesbank has developed an inverse stress testing model that captures an abrupt interest rate rise in combination with policy holders lapsing their contracts.
Institute a harmonized and legally binding deposit guarantee of €100,000, backed by adequate prefunding.Germany is required to transpose the recast Directive on Deposit Guarantee Schemes (Directive 2014/49/EU, the “DGS Directive”) into national law by 3 July 2015. The implementing legislation (DGSD-Umsetzungsgesetz – DGSD Implementation Act) has already passed the Bundestag in March 2015. The law will enter into force on 3 July 2015. The hearing of the Bundestag’s financial committee was held on 20 February 2015 with the Bundesbank in attendance.
Clarify the interaction between the restructuring fund and the various deposit guarantee and mutual protection schemes.The BRRD provides that resolution funds may only be used if no other private sector measures, including measures by institutional protection schemes (if institutional protection arrangements are concerned), would prevent the failure of the institution. The role of the German national restructuring fund is redefined by the SRM amending act (Abwicklungsmechanismusgesetz). The national fund will be used regarding firms which are within the scope of the BRRD, but neither within the scope of the Delegated Act of the Commission nor within the scope of the SRM.
Finalize specific strategies for exiting from the government support to banks, and require the affected banks to formulate strategic plans.There are no SoFFin guarantees outstanding (31.12.2014). The amount of SoFFin capital measures was reduced from 17.1 billion euros (31.12.2013) to 16.8 billion euros (31.12.2014). Effective 19 December 2014, the winding up institution FMS Wertmanagement AöR has acquired DEPFA BANK plc, Dublin – together with its subsidiaries – from Hypo Real Estate Holding AG. With regard to the winding up institution Erste Abwicklungsanstalt (EAA), a wind down of its portfolio is gradually ongoing. On 22.02.2015, EAA signed a share purchase agreement regarding the sale of Westdeutsche ImmobilienBank AG, which EAA took over from the former WestLB in 2012, to Aareal Group. The final transfer of the shares of Westdeutsche ImmobilienBank AG to Aareal Group (closing) will take place as soon as all closing conditions (e.g. regulatory approvals) have been fulfilled. The sale of Westdeutsche ImmobilienBank AG will reduce the loans and securities in EAA’s portfolio by approx. 10 billion € (the EAA’s assets amounted to 80 billion euros as at 30.09.2014).
Develop a comprehensive strategy aimed at improving the efficiency and stability of the banking system:
  • Establish viable business models for the Landesbanken;

  • Loosen the regional constraints under which local banks operate;

  • Open up the public banks to private participation; and

  • Strengthen these banks’ governance to reduce noncommercial influences.

The reform of the Landesbanken is still under way, with headcount, aggregate balance sheets and RWAs still adapting to the challenging circumstances. During 2014, legacy issues have been further reduced in some cases. Overall, for the Landesbanken sector, capital has improved. Earnings are still at a relatively low level (with significant differences across the individual institutions). Business models - which have also become a focus of attention at the ECB - have to be reviewed to adapt to the new operating and regulatory environments. Sustaining restructuring efforts are key to ensuring the viability of business models. There are no plans to loosen regional constraints on local banks, open up public banks to private participation, and reduce non-commercial influences.
Appendix IV. Public Debt Sustainability Analysis

Public debt declined further in 2014, and is expected to continue to be sustainable, given high primary surpluses and a favorable interest rate-growth differential projected through the medium term. The public debt-to-GDP ratio falls steadily under baseline projections, from 74.7 percent in end 2014 to less than 60 percent in 2020. A negative growth shock represents the largest risk to the debt outlook. Nevertheless, debt would swiftly return to a firm downward path after the shock. The realization of contingent liabilities related to future bank recapitalization needs or worse than expected performance of winding-down institutions would push debt up by about 3 percent of GDP and gross financing needs would rise to 12 percent of GDP in the near term. Interest rate or primary balance risks are important but their impact remains limited.

A. Baseline Scenario

Macroeconomic assumptions. Real GDP growth is expected to inch up to 1.8 percent in 2015-16 (non calendar-adjusted rate), supported by the stimulus provided by QE and lower oil prices. In the medium run, growth should converge to its potential level, estimated 1.3 percent. Inflation – based on GDP deflator – is forecasted to temporarily rise to 2 percent in 2015, given a fall in import deflator reflecting lower oil prices and robust wage growth, and converge to lower levels thereafter. With QE pushing down sovereign interest rates at all maturities, the baseline scenario entails a considerably lower average interest rate than one year ago, and dropping from 2.3 in 2014 to about 1½ percent in 2020.

Germany’s high level of government debt calls for using the higher scrutiny framework. Public gross debt is still 15 percent of GDP above the indicative DSA threshold for high scrutiny of 60 percent. Debt increased significantly over 2009-2010, reaching a peak of 82.5 percent of GDP, reflecting sizable fiscal stimulus, large financial sector support and euro zone crisis-related lending. Since the peak, it has declined gradually on the back of fiscal consolidation and a favorable interest rate-growth differential. Estimated gross financing needs were marginally below 15 percent of GDP in 2014, but are expected to fall further through the forecast horizon.

Realism of baseline assumptions. The forecasts of macro-fiscal variables affecting debt dynamics have been on the conservative side. The median forecast error for real GDP growth during 2006–2014 is 0.15 percent, suggesting that there is small downward bias in the staff projections, but the forecast bias is in line with other surveillance countries. Similarly, the median forecast error for inflation (GDP deflator) is 0.54 percent, suggesting that the staff overestimated inflation in the past (particularly post-2009). The median forecast bias for the primary balance is relatively large, at 1.16 percent of GDP, among the most conservative for surveillance countries.

Cross-country experience suggests that the projected fiscal adjustment is feasible. The maximum 3 year adjustment in the cyclically-adjusted primary balance (CAPB) over the projection period (½ percent of GDP) is not ambitious in cross-country comparison. Germany was able to deliver larger fiscal consolidations in the past, notably in 2011 and 2012.

B. Shocks and Stress Tests

Germany’s government debt would not surpass 75 percent of GDP under plausible macro-fiscal shocks, while gross financing needs would remain below 15 percent of GDP. Under all considered macro-fiscal stress tests, both the debt-to-GDP ratio and gross financing needs either continue to fall or swiftly return to a downward path after the shock. Temporary shocks to real GDP growth, a combined macro-fiscal shock, or a contingent liability shock would nonetheless drive a temporary increase in debt and/or gross financing needs. Given the historical variability of growth, debt dynamics in Germany is most sensitive to growth shocks (detailed results below).

List of shocks and stress tests1

  • Growth shock. Under this scenario, real output growth rates are lower than in the baseline by one standard deviation over 2016-17, i.e. 2.9 percentage points. The assumed decline in growth leads to lower inflation (0.25 percentage points per 1 percentage point decrease in GDP growth) and the interest rate is assumed to increase 25 basis points for every 1 percent of GDP worsening of primary balance. Debt (gross financing needs) would peak at 75 (12) percent of GDP in this case, and converge to 66 (9) percent of GDP by 2020.

  • Primary balance shock. This scenario examines the effect of a dual shock of lower revenues and rise in interest rate, leading to a cumulative 1.6% deterioration in primary balance over 2016-17 (one standard deviation shock to primary balance). The shock would result in a modest deterioration of debt dynamics.

  • Interest rate shock. This scenario assumes an increase of 372 basis points increase in debt servicing costs throughout the forecast horizon, mimicking the historical maximum interest rate experienced since 2005. The effect on public debt and gross financing needs would also be relatively modest.

  • Additional stress test: Combined macro-fiscal shock. This test combines shocks to growth, the interest rate, and the primary balance; while avoiding double-counting the effects of individual shocks. The impact on debt dynamics is slightly worse than that of a growth shock.

  • Additional stress test: Contingent fiscal shock. This scenario assumes a cumulative 3 percent of GDP (about 90 billion euros) additional support to the financial sector over 2016-2017 comprising of additional re-capitalization needs in the banking system (55 billion euros), a call on half of capital shield guarantees (25 billion euros), and worse than expected performance of portfolios of winding-down institutions (10 billion euros). While a highly relevant shock, the assumed magnitudes and timing are likely to be on the onerous side. Still, the impact on the debt ratio is relatively limited, and a convergence to 60 percent is still achieved in 2020. Gross financing needs would remain comfortably below 15 percent.

Germany Public Sector Debt Sustainability Analysis (DSA) - Baseline Scenario

(in percent of GDP unless otherwise indicated)

Source: IMF staff.

1/ Public sector is defined as general government.

2/ Based on available data.

3/ Long-term bond spread over German bonds.

4/ Calendar-unadjusted growth rate.

5/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.

6/ Derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

7/ The real interest rate contribution is derived from the numerator in footnote 5 as r - π (1+g) and the real growth contribution as -g.

8/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).

9/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.

10/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Germany Public DSA - Composition of Public Debt and Alternative Scenarios

Source: IMF staff.

Germany Public DSA - Stress Tests

Source: IMF staff.

Germany Pubic DSA - Realism of Baseline Assumptions

Source: IMF staff.

1/ Plotted distribution includes surveillance countries, percentile rank refers to all countries.

2/ Projections made in the spring WEO vintage of the preceding year.

3/ Not applicable for Germany, as it meets neither the positive output gap criterion nor the private credit qrowth criterion.

4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP, Percent of sample on vertical axis.

Germany Public DSA Risk Assessment

Source: IMF staff.

1/ The cell is highlighted in green if debt burden benchmark of 85% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

2/ The cell is highlighted in green if gross financing needs benchmark of 20% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are:

400 and 600 basis points for bond spreads; 17 and 25 percent of GDP for external financing requirement; 1 and 1.5 percent for change in the share of short-term debt; 30 and 45 percent for the public debt held by non-residents.

4/ Long-term bond spread over German bonds, an average over the last 3 months, 24-Mar-16 through 22-Jun-16.

5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.

Appendix V. External Sector Report Country Page: Germany
Overall Assessment
Foreign asset and liability position and trajectoryBackground. Germany’s positive net international investment position (NIIP) was reduced to close to balance in the years following reunification. Since the beginning of the millennium, the NIIP recovered and reached 33 percent of GDP at end-2014. 1/ The pace of NIIP build-up has fallen short of the cumulated current account surpluses but returns (excluding revaluations) earned on assets have been higher than those paid on liabilities since 2004. The NIIP is expected to continue to grow as the CA surplus remains sizable in the medium term. German financial corporations have a large positive net portfolio investment position (38 percent of GDP), while the general government—in part reflecting Germany’s safe haven status—has a large negative position (40 percent of GDP). During the crisis, the Bundesbank accumulated large net claims on the Eurosystem (Target2), which stood at 16 percent of GDP at end-2014.

Assessment. Safe haven status and the strength of its current external position limit risks.
Overall Assessment:

Germany’s external position in 2014 was substantially stronger than implied by medium-term fundamentals and desirable policy settings. Subsequent developments as of May 2015, notably the energy import price declines and the depreciation of Germany’s REER, point toward a further strengthening of the external position.

Recent energy price declines and the depreciation of the euro, assuming these trends are not reversed, are expected to put an upward pressure on the current account in 2015.

Staff projects some rebalancing in the medium run due to stronger wage growth relative to euro area trading partners and higher domestic demand.

Potential policy responses:

Policies should generate positive demand spillovers to the rest of the euro area and focus on boosting growth potential and reducing the German current account surplus. Policy priorities include higher public investment, service sector and energy policy reform.
Current accountBackground. The current account has averaged 6.2 percent of GDP over the last decade and reached 7.6 percent of GDP in 2014, a 0.8 pp. increase relative to 2013. Most of the increase is accounted for by an improvement in the gas and oil balance, with about equal contributions from declines in volumes and prices. This improvement is expected to strengthen further in 2015, as energy prices should remain lower than in 2014. REER depreciation since mid-2014 is expected to put further upward pressure on the CA, though it will partly offset the decline in the oil price. On a geographical basis, the surplus vis-à-vis stressed countries in the euro area remained stable in 2014, after declining substantially in recent years. The saving-investment balance of the non-financial corporations and the government each contributed about ½ percent of GDP to the improvement in the current account in 2014 relative to 2013.

Assessment. The cyclically-adjusted current account balance stood at 8.1 percent of GDP in 2014, which is 3-5 percentage points of GDP stronger than the value implied by fundamentals and desirable policies. Staff assesses the norm at 3-5 percent of GDP. The norm implied by the EBA model is 3.9 percent. 2/
Real exchange rateBackground. As of May 2015, the CPI based real exchange rate has depreciated in effective terms by about 6 percent from its 2014 average primarily because of nominal bilateral depreciations vis-à-vis the USD and the RMB. These exchange rate movements are related to the expected monetary tightening in the U.S. and the implementation of quantitative easing in the euro area. Despite the recent depreciation trend, various measures of REER were 0-3.5 percent more appreciated in 2014 than in 2013 on an annual average basis.

Assessment. Staff’s assessment for 2014 is of a REER undervaluation of 5–15 percent. The EBA REER Level model yields an undervaluation of about 16 percent. The undervaluation implied by the CA regression model using standard trade elasticities is 7-12 percent. 3/
Capital and financial accounts: flows and policy measuresBackground. Before the crisis Germany exported capital primarily in the form of bank outflows. During the crisis, capital flow reversals particularly affected portfolio investment. In 2014, net portfolio and direct investment flows constituted about ½ and 1/3 of the capital and financial account balance, respectively. The stock of Germany’s net (Target2) claims on the Eurosystem went down from a peak of €750 billion in August 2012 to €532 billion in April 2015. Assessment. Lower exposure to the Eurosystem and a resumption of private capital outflows are associated with reduced euro area financial stress and a partial reversal of euro area financial fragmentation.
FX intervention and reserves levelBackground. The euro has the status of global reserve currency.

Assessment. Reserves held by euro area countries are typically low relative to standard metrics. The currency is freely floating.
Technical Background Notes1/ Germany’s balance of payments statistics, including the NIIP, are not comparable to those reported in last year’s country page due to the transition to BPM6.


The rapidly-aging population contributes 3.3 percentage points to the estimated EBA CA norm of 3.9 percent of GDP. Most of the EBA-estimated gap for 2014 reflects the regression’s residual rather than gaps in the policies included in the EBA model.

3/ The EBA REER Index model has an unusually poor fit for Germany, predicting a depreciating trend that has not occurred. The result for 2014 is an estimate of overvaluation (of 7.3 percent) that has been discarded from the assessment as implausible, including in light of the assessment that the CA is too strong.

According to stress test results published by the European Banking Authority, a total of five German banks would have had a capital shortfall in the adverse scenario under a fully loaded (as opposed to phase-in) common equity Tier 1 metric.

The European Commission’s 2015 Aging Report projects that potential GDP growth will fall to 0.9 percent during the 2020’s and to 0.8 percent in the following decade.

See Chapter 1, World Economic Outlook, Spring 2015.

See Chapter 1, Global Financial Stability Report, Spring 2015.

See “Which Policies Can Boost German Growth and Reduce the Current Account Surplus?” Chapter III, Selected Issues for the 2014 Article IV Consultation. The paper also found that a fiscal expansion through lower taxes or higher consumption spending would have only small outward spillovers.

See “Services sector performance and product market regulation” Chapter IV, Selected Issues for the 2014 Article IV Consultation for greater detail.

At end-2013, households’ equity holdings were only 19 percent of their total financial assets in Germany, compared to 28 percent in France and 47 percent in the United States. Reflecting low household appetite for equity investments, foreign residents own the majority of equities in listed companies (57.1 percent, rising to 63.7 percent for companies included in the flagship DAX index, as of end-May 2014).

For more details, see “The German Life Insurance Sector: Confronting the Challenges of Low Interest Rates,” Chapter VII, Selected Issues, 2014 Article IV Consultation. The pension funds sector is facing a similar problem, but is much smaller in size. At end 2013, total assets were EUR 923 bn in the life insurance sector versus EUR 167 bn in the pension funds sector.

The current framework (Solvency I) is mainly based on historic cost accounting and is not risk-based. As a result, the immediate potential solvency impact of low interest rates under Solvency I is limited. The implementation of Solvency II from January 1, 2016 (with a phase-in period of 16 years) will see a gradual move to a market value and a risk-based solvency requirement that will explicitly calculate the interest rate risk capital surcharge and discount insurance liabilities using risk-free rates as a basis. As a result, any problem in meeting own funds requirements owing to low interest rates will come to light sooner.

The Bundesbank study published last November concluded that in a severe stress scenario the market share of impaired insurers in 2023 would drop from 43 percent to 17 percent as a result of the reform, and that the balance sheet shortfall would be EUR 1.8 bn. No capital shortfall estimate was provided. The Bundesbank is planning to update these simulations in the near term.

Given that virtually all outstanding sovereign debt is denominated in euros, the scenario of a real exchange rate shock would not have a relevant effect on debt and is therefore not discussed.

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