2017 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Member Countries
In my capacity as President of EURIMF, I submit this Buff statement on the Article IV consultations with the euro area. It reflects the common view of the Member States of the euro area and the relevant European Union Institutions in their fields of competence.
The authorities of the euro area Member States and the EU Institutions are grateful for the open and fruitful consultations with staff and for their constructive policy advice.
The authorities are in broad agreement with the findings and recommendations in the staff report. The strength of the cyclical recovery is indeed a positive development that signals the improved fundamentals among euro area economies. Underlying weaknesses remain nonetheless significant. Future growth depends therefore on addressing those weaknesses—including notably the remaining legacies of the crisis, slow productivity growth and the insufficient structural and nominal convergence. The current favourable economic and political conditions need to be seized as an opportunity to step-up the delivery of the reform efforts—both at national and European level—while strengthening the architecture of the Economic and Monetary Union and preserving responsible fiscal policies.
Euro area economic situation and risks
The authorities largely concur with the IMF staff’s assessment that the recovery has further strengthened into broad-based expansion, which the staff expects to continue in 2018. The European Commission forecasts are broadly in line with those of the IMF, amidst a supportive policy mix, reduced uncertainty and an improved global outlook. Risks are more balanced than before. On the internal side, political uncertainty has receded markedly but crisis legacies remain significant in some countries, reducing their ability to withstand future shocks. The risk of negative feedback loops between banks and sovereigns appears well contained. In high public debt countries, fiscal adjustment needs to continue also with a view to increasing countries’ resilience once the window of low interest rates starts closing. Conversely, external risks have gained in prominence, notably as regards the uncertain policy stance of key trading partners, the relationship with the United Kingdom once it exits the EU, and broader geopolitical and security developments. On the upside, the positive momentum could lead to higher-than-expected growth.
Economic and confidence indicators have continued to firm up. Improving household balance sheets and falling unemployment are expected to support consumption, while the expansion in investment looks set to continue, supported by the pick-up of construction from a very low level. The optimism that underlies survey results could partly be associated with the brighter economic environment globally, which should impact positively euro area exports, even if it is now partly mitigated by a stronger euro. Domestic confidence factors are also likely at play, including the improved political climate and raising hopes that Europe will re-energise its process of economic integration.
The authorities concur with the staff´s assessment that, while the euro area’s external position is broadly in line with medium-term fundamentals, imbalances at the national level remain sizeable. Adjustments have mainly taken place in countries with large net external liabilities. Net external debtor countries, which earlier had persistent current account deficits, have maintained surpluses over the past four years, leading to a small improvement in their net foreign asset positions. The persistent surpluses of large net external creditor countries, have not shrunk significantly or have in some cases even grown larger, due inter alia to high national saving and comparatively weak domestic investment. Relative price adjustment at the national level would also contribute to the euro area rebalancing. Absent adjustment, the net international investment positions of persistent surplus countries could grow over the medium term.
As for the medium-term outlook, the authorities agree that delivering on the right reforms is essential—both at the European and national levels—to increase the productivity of the economies, as well as their resilience going forward, and to resume convergence among them. Despite the recovery in consumption, investment remains relatively weak. This reduces the future growth potential and, together with the overall high savings rate stands behind the euro area’s current account surplus. Banking sector weaknesses, with large differences among countries, could hamper a stronger recovery in investment as well. At the same time, the situation in the labour market is still far from equilibrium. Unemployment has been falling but remains relatively high in several member states, and hours per worker have not recovered to pre-crisis levels as part-time employment has increased. Despite closing output gaps substantial slack in this regard remains. This, together with slow productivity growth, is seen as preventing wage growth from picking up more strongly. Long-term unemployment remains a concern as well, not only for its impact on potential growth but also on concerned workers.
Monetary policy and inflation outlook
The ECB’s monetary policy measures have proven powerful in generating very favourable financing conditions that are supporting the ongoing economic expansion and the return of inflation towards levels below, but close to, 2 percent over the medium term. Despite the strengthened economic expansion in the euro area, inflation developments continue to remain subdued. In particular, underlying inflation pressures remain low and should increase only gradually over the next two years, as the economic expansion has yet to translate into stronger inflation dynamics. Therefore, a very substantial degree of monetary accommodation is still needed for underlying inflation pressures to build up and support headline inflation in the medium term. However, strengthening economic growth in the euro area must be supported by much more decisive actions in other policy areas. Achieving higher sustainable economic growth requires stepping up the implementation of structural reforms and a more growth-friendly composition of public finances.
Fiscal performance and governance
On the fiscal policy side, the authorities broadly agree with the staff’s assessment that, in line with the Stability and Growth Pact, fiscal policies should reflect economic conditions and sustainability risks at Member State level—while ensuring an effective co-ordination of economic policies. After strong consolidation during the crisis, the fiscal policy stance in the euro area turned broadly neutral in 2015–16 and is set to remain so in 2017, with a slight overall contraction due to lower debt servicing costs—according to the Commission 2017 spring forecast. The fiscal stance in 2017 is expected to vary across Member States. Based on the change in the structural primary balance, some countries are expected to have an expansionary stance, while only a limited number are expected to have a contractionary stance.
Challenges in terms of fiscal sustainability remain in a number of countries where public debt is high, which may negatively impact growth in the medium term and is a major source of vulnerability to adverse shocks. The stability programmes submitted in April confirm that most Member States plan to converge to their medium-term budgetary objectives in line with the requirements of the Pact, although some back-load consolidation as from 2018–19.
The authorities concur with the staff’s recommendations of a broadly neutral fiscal stance for the euro area in 2018, given the need to ensure sustainability and the need to support investment to strengthen the recovery. They also share most of the staff’s assessment of potential output and the output gap in the euro area. The Commission forecasts an earlier closure of the output gap (in 2018 rather than 2019). However, this is mostly due to small differences in the forecasts for actual GDP rather than potential GDP at euro area level. The authorities also agree on the importance of the composition of public finances. Member states that have outperformed their medium-term objectives have been invited to continue to prioritise investments to boost potential growth while preserving the long-term sustainability of public finances whereas other countries should focus on rebuilding buffers and reducing vulnerabilities. There is still a large scope in most euro area countries to reorient public expenditure towards more productive and socially efficient uses, as well as to improve the efficiency and growth friendliness of taxation and reduce the tax wedge on labour.
Concerning the enforcement of the Pact, the Council and the Commission remain fully committed to the fiscal rules and the limited degree of discretion that the rules confer on the Institutions represents an essential element of the governance framework. In effect, the agreed framework should not only be applied mechanistically: some economic judgement will always be necessary. It is also important to recall that consolidation has borne fruits. 23 EU Member States were under the excessive deficit procedure (EDP) in 2009, this is now down to 4. The aggregate headline deficit in the euro area fell to 1.5 percent of GDP last year while the debt-to-GDP ratio has consistently declined since 2014. In sum, the evidence seems rather to suggest that the EU’s fiscal rules are working.
At the same time, the authorities also believe that a predictable, transparent and consistent application of the Pact is crucial to fully enforce commitments, to ensure that all Member States are treated equally and to preserve the credibility of the European fiscal rules.
The consideration of whether a fiscal capacity at euro area level would be appropriate is part of a broader reflection on the future of Europe and the strengthening of the EMU. The simplification of the fiscal rules can be seen as part of this process. The European Commission put forth a number of suggestions in a reflection paper on the deepening of the Economic and Monetary Union published on 31st May 2017.
Balance sheet repair and financial architecture
Financial conditions have overall remained favourable, amid supportive monetary policy and progress achieved towards the Banking Union. While differences still remain among national banking sectors, banks used the additional liquidity related to the ECB’s expanded asset purchase programme to grant loans. Lending rates for both euro area households and non-financial corporates remained at record low levels, while credit standards on loans to both sectors eased somewhat further, mostly driven by competitive pressure. Residential mortgage credit growth has remained broadly stable at moderate levels, with heterogeneous developments across countries, while corporate sector credit growth continued to recover. The latest bank lending and firms’ access to finance surveys signalled improvements in the availability of external finance, including for SMEs. As the recovery firms up, the authorities expect that these positive developments will continue.
Banking sector profitability remained low. While profitability outturns and expectations have improved, as largely reflected in the rise in banks’ equity prices over the last months, and the broad dispersion of profitability among EU banks has somewhat narrowed, challenges to reach adequate levels of profitability remain very much pressing. The authorities agree that reducing overcapacity can be accomplished by banks, either internally or by (cross-border) mergers and acquisitions, resolutions or market exits.
The authorities agree that efforts should continue to accelerate and advance bank balance sheet repair across the euro area. While the overall level of non-performing loans (NPLs) has declined, the dispersion of NPLs among countries remains wide and the pace of NPL resolution remains overall steady but slow. The ECB’s Guidance to banks on NPLs, published at the end of March, should be used as an inspiration of best practices for significant banking institutions. The Action Plan to Tackle NPLs in Europe endorsed by the ECOFIN Council in July stressed the importance of a comprehensive approach, combining a mix of complementing policy actions at national and EU level. A particular emphasis is put on the policy areas of supervision and structural reforms (including insolvency and debt recovery frameworks), as well as on the development of secondary markets for NPLs, and the restructuring of the banking system. The Commission has also launched a public consultation on how to best spur the development of secondary markets for NPLs in order to speed up NPL disposals.
The authorities broadly share staff’s views concerning the completion of the Banking Union. In line with the roadmap of June 2016, work should continue to complete the Banking Union with regard to risk reduction and risk sharing, including a European Deposit Insurance Scheme and making the common backstop for the Single Resolution Fund operational at the latest by the end of the Fund’s transitional period.
Further progress has been made towards the objective of establishing a Capital Market Union in the EU. The completion of CMU will strengthen the EU’s resilience to shocks and facilitate the efficient allocation of capital. So far nearly two thirds of the actions have already been delivered. The July Council adopted conclusions on the Commission’s review of the CMU action plan, aimed at securing the building block for a fully-fledged capital markets union by the end of 2019. Greater harmonization of financial regulatory and supervisory regimes, and improved access to non-bank financing sources, will provide greater investor certainty and diversify firms’ funding options, boosting investment. Improvements in areas, such as securities ownership rules, and corporate insolvency proceedings, are still pending, while new action items such as the possibility of enhanced supervisory powers for the European Supervisory Authorities (ESA), potential revisions to the prudential treatment of investment firms, and measures to encourage FinTech and sustainable finance, should further enhance the functioning of the Single Market.
Structural reforms at Member State level
The authorities agree that well-designed and sequenced structural reforms—if fully implemented—can have a sizeable positive medium-term impact on potential growth and contribute to enhance the adjustment capacity of the euro area. As noted in the staff report, product market reforms should be prioritised, as they entail few relevant short-term costs, while labour market reforms need to be sequenced with caution and with appropriate support. All countries should prioritize reforms to improve the investment climate, including creating incentives to favour investment, and have effective insolvency regimes and public administrations in place. Strengthening competition, improving price responsiveness and lowering entry barriers would also have a positive impact on investment. Moreover, a coordinated implementation of reforms by Member States can produce higher gains. This should particularly be the case at the current juncture, with persistently very low inflation and interest rates, when multipliers are high and potential spillovers of structural reforms are also expected to be larger.
The EU Institutions continue to promote and monitor structural reforms by means of a range of tools within the European Semester. As regards country-specific recommendations (CSRs), while implementation has been uneven across policy areas and countries, progress has been more notable in the areas of fiscal policy and fiscal governance, active labour market policies, taxation policies, social policies and financial services. Moreover, considering a multi-annual rather than annual horizon, the large majority of CSRs have seen good progress. Long-term structural issues take time to be addressed and tangible results may take time to show. Nevertheless, measures to improve the long-term sustainability of public finances, competition in services and the business environment have lagged behind.
The authorities believe that policy implementation is helped by the use of the Macroeconomic Imbalance Procedure (MIP) and that the MIP should be used to its full potential, with the corrective arm applied where appropriate. MIP surveillance has improved the policy dialogue between the Commission and Member States. It has notably helped raising awareness about reform needs and created the conditions for more effective surveillance, complemented where needed by technical assistance by the Commission, and peer pressure and support. Results have been particularly evident for some countries identified with excessive imbalances at some point in time and in the absence of macro-economic adjustment programmes (such as Spain, Slovenia, and Croatia). A recent survey conducted by the European Court of Auditors indicates that Member States see the MIP as having a positive impact on policy implementation.
The authorities consider that higher economic and social convergence—a key objective of any process of economic integration—can be achieved through structural reforms, higher economic growth and actions to address inequality. The crisis of the years 2007–08 marked the end of the convergence trend and the start of a divergence trend, which is only slowly being corrected. This correction is a positive development but its slow path requires additional policy actions. In any event, convergence has been higher in the euro area than within the EU as a whole, as noted in the staff report.
The introduction of structural reforms can be facilitated by the use of benchmarking, meaning the cross-examination against a particular benchmark of indicators related to economic and social performance and policies in each Member State. This can be a useful tool to identify the need for action at an early stage, monitor progress and effectively communicate results. Most importantly, it can also help to increase the ownership of reforms among Member States and facilitate their implementation. Some first possible benchmarks have already been agreed among Commission and Member States in the areas of tax wedges and pensions. The Commission is currently developing further benchmarks and the exchange of best practices across policy areas with Member States.
The authorities also concur on the importance of deepening the Single Market to unlock the full potential of investment and to bring about higher productivity growth. At EU level, the Commission has launched a number of initiatives regarding the Single Market, in particular, measures to develop the Capital Markets Union, deepen market integration for both services and products, complete the Energy Union and establish a true Digital Single Market. All these initiatives contain specific measures to remove obstacles to investment, in the context of the third pillar of the European Investment Plan. Single Market policies have high potential as they are decided jointly and apply to the whole of the EU. However, this does not mean that the commitment and agreement of Member States are any less necessary to deliver those reforms. Work is ongoing on concrete proposals linked to the enforcement of single market rules as well as measures in the area of business services, including facilitating their cross-border provision, business restructuring and insolvency, and the creation of a simple, modern and fraud-proof VAT system. A thorough implementation and enforcement of additional key measures in the 2015 Single Market Strategy would be positive for growth. At the same time, the European Union remains committed to open and fair trade, as proved by the recent agreement of July 6th on the principles of an Economic Partnership Agreement between the EU and Japan. This is also the first international trade agreement to include a clear commitment to fight climate change and support the Paris goals.
Deepening of the EMU framework
The authorities agree that a favourable environment like the current one, after several major risks have been averted, should be seized to address shortcomings in the design and functioning of the Economic and Monetary Union (EMU) and step-up the delivery of reform of EMU. A range of ideas, including those suggested by the Commission in its reflection paper, will be explored in the coming months with the ambition of achieving a more complete and resilient architecture, and capable of delivering higher growth and stronger economic and social convergence. Completing the Banking Union and the Capital Markets Union are key priorities, with the measures indicated above. Furthering the principles of responsibility and solidarity, legitimacy and accountability rests on improving policies and their delivery at national and EU level. The authorities would welcome exchanges of views with the Fund on these issues during the next Article IV consultations.