Germany: Staff Report for the 2003 Article IV Consultation

The 2003 Article IV Consultation discussions took place against a backdrop of serious concerns about the health and prospects for the economy. The authorities saw the revised policy strategy as providing an important boost to confidence and the right balance of supply-side initiatives and demand-side support to revitalize growth. The key challenge in the financial sector is to maintain a healthy balance between competition and financial stability. The authorities have made progress in bringing key elements of their reform program closer to implementation.

Abstract

The 2003 Article IV Consultation discussions took place against a backdrop of serious concerns about the health and prospects for the economy. The authorities saw the revised policy strategy as providing an important boost to confidence and the right balance of supply-side initiatives and demand-side support to revitalize growth. The key challenge in the financial sector is to maintain a healthy balance between competition and financial stability. The authorities have made progress in bringing key elements of their reform program closer to implementation.

1. This supplement reports on information that has become available since the issuance of the staff report and on discussions with the authorities via videoconference on October 28, 2003.1 The new information corroborates the thrust of the staff appraisal.

Economic developments and outlook

2. Business confidence continues to strengthen, consistent with recovery beginning toward the end of this year. In October, the Ifo composite index increased for the sixth straight month. Until October, the rise in the Ifo index had been fueled by its forward looking component, while the indicator of current conditions stagnated. By contrast, the latest reading also shows a noticeable uptick in current economic conditions. Expectations are nevertheless still running ahead of actual economic developments and will thus need to be further validated by hard evidence of reviving output in the months ahead.

3. The newly released official forecast is in line with the consensus. The forecast projects growth of zero in 2003 and 1½-2 percent in 2004. The authorities see the risks to the projection as balanced. The main downside concern would be if the euro were to appreciate sharply. The authorities stressed that confidence building via implementation of needed structural reforms will be important to ensure that domestic demand provides a durable base for recovery.

  • Recent developments are consistent with staff’s projection of stagnation in 2003 and mild recovery (growth of 1½ percent) in 2004.

Fiscal developments and outlook

4. Recent data indicate a wider deficit in 2003 than staff had estimated in the staff report. Although, tax data contain no major surprises—in the first nine months of 2003, tax revenue was 0.3 percent above its level of the corresponding period of 2002—social security contributions have been weaker and outlays higher than expected. Overall, staff would see the deficit somewhat above 4 percent of GDP in 2003, compared to the estimate of 3.9 percent in the staff report, implying a reduction of the structural deficit of less than ½ percent of GDP. The authorities have yet to revise their fiscal projection (they will do so in the context of a supplementary budget to be submitted in November) but have a similar view of the fiscal picture for 2003.

5. Progress has been made in reaching political agreement on the 2004 budget. Consensus on making significant cuts in subsidy programs has emerged with a cross-party commission proposing across-the-board reductions in a broad range of subsidies by 10 percent over the next three years. The quantitative impact of these cuts would be roughly in line with staff assumptions for its baseline fiscal projection. Finance Minister Eichel continues to press for additional, targeted elimination of housing subsidies and commuter allowances. In response to the weakness in the social security funds, and with a view to holding down contribution rates, the government has also adopted an emergency pensions package that foregoes a scheduled pension increase in 2004 and makes pensioners pay long-term health care contributions in full. Passage of the budget is expected in December.

6. The authorities now expect that the general government deficit will exceed 3 percent of GDP next year. They remain committed to reducing the structural deficit by at least 1½ percent of GDP over 2004-06. While the authorities still aim to make progress in this regard in 2004, they acknowledged that this will be difficult given tax cuts.

  • Recent developments continue to suggest that the general government deficit is likely to remain around 4 percent of GDP in 2003 and 2004, with an unchanged structural deficit in 2004. This underscores staff’s call for early identification of credible, structural savings, such as elimination of housing and commuter subsidies, to fill the remaining fiscal adjustment gap for 2004-06.

Structural reforms

7. The authorities have made progress in bringing key elements of their reform program closer to implementation (see table below). On labor market reforms, the key initiative to merge unemployment and social assistance has been adopted by the lower house, albeit with some softening to define acceptable employment as a job paying the wage agreed in collective wage bargaining. The opposition-controlled upper house will now consider the reform. On pensions, the cabinet has approved adding a sustainability factor to the pension formula, which would lower pension costs by an estimated 1½ percent of GDP by 2030. Rather than raising the statutory retirement age, the government is focusing efforts on bringing the effective retirement age closer in line with the statutory retirement age (65 years) by phasing out early retirement schemes and not allowing three years of training/education to count toward pension rights.

  • At this stage, implementation of the authorities’ all-important structural reform program appears on track, although political hurdles remain ahead.

Key Reforms: Implementation Status

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The principal representative for the authorities was Ministry of Finance State Secretary Koch-Weser.

Germany: Staff Report for the 2003 Article IV Consultation
Author: International Monetary Fund