Abstract
2018 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 and FSAP 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 Article IV staff report and Financial System Stability Assessment. We welcome the acknowledgement of the progress achieved in institutional and risk-reduction reforms, while agreeing that risks have heightened recently in some areas and the work is far from done.
Let me refer to these two reports in turn:
STAFF REPORT FOR THE 2018 ARTICLE IV CONSULTATION
Economic outlook
The authorities concur with the staff’s assessment that economic growth remains strong, broad based and job friendly, even though underlying inflation has been subdued. Steady job creation underpins the robustness of the recovery while wage growth remained below 2 percent for most of the last six years. As highlighted by staff, the euro area is still reaping the fruits of wide-ranging policy efforts but most recent readings suggest that the recovery has passed its peak. Our real GDP growth projections for 2018 and 2019 are in fact very much aligned.
We agree with staff that downside risks have heightened significantly since last year. Yet, we believe that staffs assessment of the likelihood and impact of those risks does not take sufficiently into account the euro area’s achievements and commitment to reforms and sound policies.
As regards Brexit, the authorities agree that the uncertainty surrounding the final outcome of the negotiations represents a downside risk. Addressing this would require negotiations to progress faster, and it should be understood that it is not possible to maintain all the current benefits while leaving the EU regulatory, supervisory, enforcement and judiciary framework. We agree that Brexit will have a negative macroeconomic impact for both the EU and the UK, albeit disproportionately larger for the latter and for some Member States. At the same time, we must caution against the estimates produced by staff, as these are highly speculative and suffer from important modeling limitations.
Our assessments of medium-term growth prospects are very much aligned. Potential growth is expected to ease amidst demographic changes, weak productivity growth and crisis legacies, including ongoing private sector deleveraging in some countries. This calls for responsible and growth-friendly fiscal policies, rebuilding buffers, prioritizing investment, and improving the quality of public expenditure and revenues. Stepping up the implementation of structural reforms will also be important to enhance productivity and reduce vulnerabilities.
Monetary policy and inflation outlook
With longer-term inflation expectations well anchored, the underlying strength of the euro area economy and the continuing ample degree of monetary accommodation provide grounds for confidence that the sustained convergence of inflation towards ECB’s inflation aim will continue in the period ahead, and will be maintained even after the gradual winding-down of the net asset purchases. Underlying inflation has been increasing from earlier lows. However, the further build-up of domestic price pressures and headline inflation that we foresee over the medium term is still conditional on the support of a sizeable amount of monetary policy stimulus. This support will continue to be provided by the net asset purchases until the year end, by the large stock of acquired assets and the associated reinvestments, and by the enhanced forward guidance on the key ECB interest rates.
Fiscal policies
The authorities agree with staffs assessment that the distribution of national fiscal policies differs from recommendations. Member States with high public debts need to increase their efforts to improve the sustainability of their public finances, while continuing to strengthen economic growth potential, taking advantage of the still robust growth while financing conditions are favorable. Conversely, Member States with stronger fiscal positions and external surpluses could prioritize investments to boost potential growth, as advised by staff, while preserving long-term sustainability.
Consistent application of the fiscal rules continues to be warranted and, with negative output gaps finally closed according to most estimates, there may no longer be the same need— ceteris paribus—to use the flexibility provided by the fiscal rules, as done in 2018 to support the incipient recovery. We do not find sufficient recognition in the staff report that our public finances compare very favorably to those of other major jurisdictions, in aggregate, which can be partly attributed to the fiscal framework in place.
External sector policies
The authorities take note of staffs assessment of the euro area’s external position, which is in line with the European Commission’s. While much progress has been achieved among net debtor countries in correcting their external imbalances, large current account surpluses remain in some creditor countries. We agree that policy levers affecting the current account are mainly at the national level and that countries need to take steps in this regard. The main drivers are levels of savings relative to investment in the non-financial corporate and household sectors, although government balances also play a role, as highlighted in the report. The underlying determinants of savings and investment in the non-financial corporate and household sectors should be further analyzed to support more tailored policy advice. Further integrating financial markets and the broader EU single market, in the context of deepening of the Economic and Monetary Union, will also help to reduce imbalances among Member States.
Paragraph 43 in the staff report singles out external surpluses as potentially fueling protectionism in deficit countries. Within the current context of growing trade tensions, there is a risk that this over-simplified message could be misused to validate irrational policies.
The EU is unambiguously committed to free and fair trade and to international cooperation based on common rules. We underline the importance of preserving and deepening the rules-based multilateral trading system. The EU is committed towards its modernization and calls on all partners to contribute to this goal. At the same time, we firmly reject measures taken on spurious grounds for protectionist purposes. The EU will respond to all actions of a clear protectionist nature in full respect of WTO rules.
Deepening of the Economic and Monetary Union (EMU)
The authorities take note of the staff assessment of financial architecture and EMU deepening reforms. The Euro Summit agreed in June to progress towards completion of the banking union, to strengthen the European Stability Mechanism (ESM) and to discuss all other relevant items. Following the agreement on 25 May, the adoption of a package of measures aimed at reducing risk in the banking industry is expected before the end of the year. The ESM will provide the common backstop to the Single Resolution Fund (SRF) and will be strengthened. Differences of views remain on the issue of a common fiscal capacity. Discussions will continue on the European Commission proposal and on other recent ideas for a common fiscal capacity to support investment, convergence and stabilization.
Continuing our efforts on completing the banking union, advancing the capital markets union and developing meaningful forms of private and public risk sharing, will help build collective resilience to future shocks, as also emphasized by staff. The Euro Summit will come back to these issues in December 2018, including on the basis of terms of reference for the common backstop, a terms sheet for the further development of the ESM. Work should also start on a roadmap for beginning political negotiations on the European Deposit Insurance Scheme (EDIS), while adhering to all elements of the 2016 Council roadmap.
This concludes my statement on the staff report for the 2018 Article IV consultation. I will now turn onto my statement on the Financial System Stability Assessment:
FINANCIAL SYSTEM STABILITY ASSESSMENT (FSSA)
In terms of financial sector oversight, the authorities welcome and broadly concur with staff’s analysis and recommendations. The emphasis placed on anti-money laundering and cybersecurity is welcome. In the area of banking, some of the recommendations of the report are already covered in existing Union legislation. However, authorities do not concur with the statements referring to mandatory relocation of central counterparties (CCP). The European Commission’s proposal does not refer to relocation, but rather to the ability to provide clearing services within the EU. Furthermore, the CCP supervision proposal aims to strengthen the EU regime for third countries in general and is not solely driven by Brexit.
Authorities welcome the recognition of the importance of the Capital Markets Union project. Further progress has been made recently through a significant number of legislation and nonlegislative initiatives, which are not covered in the FSSA. While the authorities agree with the main messages on macro-prudential supervision, developing new instruments for the nonbanking sector is at a preliminary stage as several Union pieces of legislation are still spreading their effects.
Authorities broadly concur with the main messages in the field of crisis management and bank resolution, such as the criticality of sufficient MREL for an effective resolution, and welcome the acknowledgement of the progress made in completing the crisis management infrastructure. Authorities wish to point out that while the recommendation to proceed quickly with the build-up of external and internal MREL is welcome and shared, it should also take into account the diversity of banking groups and recognize the merit of transitional periods. Authorities are nevertheless urging all banks to build up the needed MREL buffers without delay in order to allow for a credible implementation of the resolution plans. Authorities furthermore welcome staffs recommendation to establish the ESM as a common backstop for the SRF.
Authorities note that a Treaty change to grant to the Single Resolution Board (SRB) the status of an “institution” may not be feasible in the short term and the SRB is already an independent agency in line with the Key Attributes. Moreover, the endorsement of resolution schemes by the European Commission does not delay resolution decisions, as the timeframe imposed by the law is just 24 hours and the EU institutions have taken all necessary arrangements to comply with this deadline. As regards the recommendation for an administrative liquidation tool for the SRB, its legal and operational feasibility is doubtful. Authorities disagree with the FSSA recommending a financial stability exemption that would allow the departure from the 8% bail-in requirements for accessing the Single Resolution Fund (SRF) and public funds. The aim of the SRF has never been to replace the bail-in tool, but to ensure efficient application of the resolution tools.
On State aid, the authorities point out that its control derives directly from the EU Treaties. Hence, the EU’s co-legislators have acknowledged the role of State aid control in the EU’s bank resolution framework, which is to ensure a level playing field between banks in- and outside the Banking Union. Whenever aid is needed, both in- and outside resolution, State aid control applies and ensures that the beneficiary bank is restructured or liquidated. Deposit insurance scheme (DIS) interventions beyond reimbursing depositors may fall under State aid control. Moreover, State aid rules require burden sharing and restructuring or market exit, thereby protecting the DIS. Finally, the application of State aid control is already fully transparent.
Regarding the withdrawal of the United Kingdom from the EU, potential financial stability risks are being monitored, including by a joint technical group between the ECB and the Bank of England. Each firm should take the necessary steps to ensure that it can continue to provide services to its clients. The financial services sector is accustomed to working in a cross-border environment, involving multiple jurisdictions.
The authorities welcome the comprehensive assessment undertaken by staff of the banking supervision methods and practices carried out by the ECB in close coordination with NCAs in the SSM. The authorities appreciate that staff recognize the increased level of supervisory intensity and intrusiveness, and the definition of clear supervisory methodologies and processes. The authorities concur with staff that the supervisory powers for relevant cross-border investment firms which carry out bank-like activities in the euro area needs to be addressed. On the EU prudential framework, the authorities welcome the recognition of the progress achieved, while they also agree that there are still important areas which are yet to be harmonized at EU level.
However, the authorities disagree with the assessment of BCP24 on Liquidity Risk as it severely misrepresents the intrusiveness, intensiveness, timeliness and efficiency of the ECB current supervisory practices and downplays its capacity and readiness to act when significant institutions’ controls are not up to its standards and expectations. The ECB takes supervisory actions well ahead of the actual manifestation of any liquidity constraints, in order to ensure that in case an outright liquidity crisis eventually occurs all relevant stakeholders are sufficiently informed and the necessary decisions can be timely made.
The authorities generally agree with the general finding of an overall increase in banks’ resilience, as concluded from their solvency and liquidity analyses of the largest euro area banks, and with the main findings of the liquidity stress-testing, albeit identified scenario specific liquidity shortfalls or vulnerabilities may often be attributed to very extreme or non-pragmatic scenario assumptions. Euro area banks have been consistently increasing their liquidity buffers as a response to regulatory changes, which appear to be one of the main drivers of the ample system-wide liquidity.
With regard to structural euro area bank profitability, the authorities broadly share staff’s assessment of its main drivers and that improving macro conditions is not sufficient to fully address this problem. While banks have made some progress in improving efficiency and tackling NPLs, high NPL stocks continue to adversely affect performance. The authorities highlight that the pace of NPL reduction is partly dependent on banks’ capital position and their ability to raise capital, and that the pace of NPL stock reduction has been accelerating since 2017. Profitability levels of euro area banks have been recovering significantly in the last years. Fragmented banking structures, cost inefficiency and little income diversification, continue to drag on the long-term profitability prospects of European banks.
Related to systemic liquidity management, the authorities take note of staffs recommendation regarding the ‘horizon scanning’ arrangements to better detect emerging liquidity strains. These will need to be carefully considered in light of the already existing arrangements, also to avoid overlaps in the responsibilities of the two functions.