Statement by Hubert Temmeyer, Executive Director for Germany, June 29, 2012

This 2012 Article IV Consultation reports that the German economy’s performance has been remarkable despite facing considerable headwinds. Several conditions are now in place in Germany for a domestic demand-led recovery. Employment creation has been robust and unemployment at 5.3 percent is at a postreunification low. Executive Directors have commended Germany’s strong macroeconomic management, which has resulted in a favorable economic performance despite the uncertain external environment. Directors have underscored Germany’s pivotal role in reducing euro area and global imbalances.

Abstract

This 2012 Article IV Consultation reports that the German economy’s performance has been remarkable despite facing considerable headwinds. Several conditions are now in place in Germany for a domestic demand-led recovery. Employment creation has been robust and unemployment at 5.3 percent is at a postreunification low. Executive Directors have commended Germany’s strong macroeconomic management, which has resulted in a favorable economic performance despite the uncertain external environment. Directors have underscored Germany’s pivotal role in reducing euro area and global imbalances.

I thank the staff for a focused and balanced analysis of the German economy and convey my authorities’ appreciation of the fruitful and detailed discussions they had with the IMF team during this year’s Article IV mission. Their dedication to gather a broad range of views and a continued dialogue is considered to be very helpful for achieving a mutual understanding of the issues at stake.

Macroeconomic outlook

The staff paper rightly describes the robust economic development of the German economy over the course of the past year and we agree that the main downside risks to the near-term outlook are of an external nature. While the discussion generally focuses more on risks arising from the debt crisis in some euro area countries, the emphasis on the high global interconnectedness of the German economy in the staff report is important and requires a broad assessment of risks. I agree with the staff on the main downside risks, but potential upside risks, in particular the possibility that uncertainty recedes more quickly than anticipated, should also be taken into consideration.

External vs. domestic drivers of economic growth

My authorities remain fully committed to further strengthening domestic sources of growth whose contribution to annual real growth has markedly increased and already surpassed the contribution of net exports in the last years. Overall, we agree with the staff that the conditions for higher domestic demand remain favorable, namely increasing household incomes and employment, strong balance sheets of households and the corporate sector, and a supportive financing environment. While a pick-up in asset prices can have positive effects on wealth and consumption, my authorities nevertheless will monitor increases closely to detect any formation of asset price bubbles early on. At the same time, since Germany is among the world’s most open large economies, external demand will naturally continue to play an important role for its economic growth. Currently, many regions in the world enjoy higher growth rates, whereas demographic strains weigh on Germany’s potential growth. Furthermore, as pointed out by the staff, German export performance also benefits other European countries.

Current account developments

In the current cyclical position of the German economy, higher domestic demand fuelled by favorable labor market developments, robust construction activity and favorable financing conditions will likely contribute to a rebalancing between euro area countries. However, in this process medium-term price stability in the euro area must be maintained. The main driver for an improved competitiveness of euro area countries with current account deficits is the continued implementation of their respective reform agendas. It is important to note that, after reaching its peak already in 2007, the volume of the German current account surplus with other euro area countries has diminished by over 40 percent by 2011.

I should emphasize that paragraph 34 of the staff report does not correctly reflect my authorities’ views, as they do not agree with the statement that the German current account position is stronger than implied by fundamentals. The mere fact that the underlying model cannot explain a country’s current account position with a limited set of fundamentals does not by itself allow such a conclusion. Furthermore, my authorities do not see that specific current account benchmarks of two or four percent of GDP, as suggested by staff, are helpful. As stated on the occasion of last year’s Article IV discussion, the German current account surplus is not the result of targeted policy measures, but the outcome of complex market processes and largely explained by a multitude of private business decisions.

Securing sustainable growth and steering through an uncertain economic environment

The continued steadfast implementation of sound structural, macroeconomic, and financial sector policies is the basis for sustainable growth, both in the short term and the medium term.

Structural policies

Regarding potential growth and the strengthening of domestic sources of growth, we agree with the staff that a higher labor participation, in particular among women and older persons, as well as increased migration will be needed. The staff’s policy recommendations are well taken, as they address foreseeable supply-side challenges on the labor market and the need to sustain the profitability and competitiveness of the German economy.

The employment rate of women and men aged 20–64 is approaching my authorities’ target of 77 percent while the EU employment rate target of 75 percent has already been surpassed. To better tap the domestic workforce, and also to attract qualified workers from abroad, the German government has established, in 2011, the “Skilled Labor Strategy” which includes measures to improve the availability of childcare facilities, to promote more family-friendly working hours in cooperation with the relevant business associations, to reduce, by 2015, the share of persons aged 20–29 that lack vocational training from 17 percent to 8.5 percent, to increase the number of academics and the share of women with a degree in natural sciences, to reintegrate the older unemployed into the labor markets, and to increase the effectiveness of existing labor market instruments.

Regarding growth-oriented tax policy, any measure will need to be analyzed in the context of fiscal sustainability. As pointed out last year, the introduction of an allowance for the normal return on new equity would result in significant revenue losses, as observed elsewhere, and is therefore not under consideration.

Fiscal policies

Fiscal consolidation and respecting the requirements of the European Stability and Growth Pact is a key common objective of all EU countries. In addition, the Treaty on Stability, Coordination and Governance, including the Fiscal Compact, was signed by 25 EU member states. Compliance with these legal commitments is essential since a sound and predictable fiscal framework, including national fiscal rules, constitutes a much needed anchor and an element of crisis resolution in an uncertain financial market environment. It will be instrumental in securing confidence through a credible fiscal policy and the reduction of elevated levels of public debt in many EU countries, including Germany.

My authorities agree with the staff that there is no need for a fiscal stimulus at the current stage of the business cycle and are skeptical about a debt-financed stimulus of the economy. The staff paper correctly reiterates the findings that potential spill-over effects from expansionary fiscal measures in Germany to relevant EMU partner countries would be negligible.

Financial sector

When assessing the vulnerabilities of the German banking sector, it has to be differentiated between specific parts of the sector. German banks differ substantially in business models and funding structure. The profitability of banks has been improving after the financial crisis with especially the savings and cooperative banks remaining profitable even during the crisis. While wholesale funding, which has been decreasing substantially, continues to be part of the banks’ funding strategy, the share of deposits relative to total liabilities has been rising for several years. The adjustment process in the Landesbanken sector is ongoing. Progress is being made with respect to reducing risk weighted assets, focusing on core business as lending to domestic SMEs and municipalities as well as downsizing, including the restructuring process of a major Landesbank.

Raising capital as required by Basel III is well on track. Additionally, the early compliance of the majority of affected German banks with the capital requirements of the European Banking Authority (EBA) has helped to foster the resilience of institutions and to address vulnerabilities. When assessing the quality of capital, it should be kept in mind that the recent EBA exercise showed that German banks are able to convert their supposedly low quality capital into core tier 1 capital. In March 2012 my authorities reactivated the Special Financial Market Stabilization Fund (SoFFin) that can provide guarantees and loans to stabilize banks, if required. This was done for precautionary purposes only with currently no foreseeable cases of utilization.

My authorities remain committed to the recommendations of last year’s FSAP to enhance the existing financial stability framework where appropriate. Financial stability requires constant work on the regulatory and supervisory framework and progress on the FSAP recommendations is being made.

Systemic oversight and macro-prudential supervision will be strengthened through an operationally independent Financial Stability Commission comprising all relevant regulatory and supervisory bodies in Germany with a central role for the Bundesbank. Its most prominent task will be the continuous analysis of financial stability, identification of potential threats and issuance of recommendations and warnings. As a precondition for successful analytical work, the Bundesbank will have access to all necessary information from the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and the possibility to request economic and trade data from financial institutions under supervision will further enhance information flows. At the same time, the BaFin will have comprehensive access to financial stability analysis conducted by the Bundesbank. It is envisaged that the Financial Stability Commission will be established by January 2013.

Further steps are being taken to improve the crisis management framework. After the bank restructuring law coming into force in December 2010 the setting up of recovery and resolution plans – in line with recommendations from the Financial Stability Board (FSB) - is progressing.