Washington, DC : The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1]with Germany. This also included a discussion of the findings of the Financial Sector Assessment Program (FSAP) exercise for Germany.[2]The publication of the Staff Report and Financial System Stability Assessment (FSSA) bundles will be followed by publication of the FSAP Technical Notes underpinning the FSSA.
Before Russia’s invasion of Ukraine, economic activity in Germany was firming up. Auto production and services activity were picking up by late 2021 and early 2022 on easing semiconductor shortages and relaxation of pandemic restrictions. The war in Ukraine has created new headwinds, including a curtailment of gas flows from Russia, higher energy prices, scarcity of key intermediate inputs, weaker external demand and confidence, and tighter financial conditions. Growth is expected at 1.2 percent in 2022 and 0.8 percent in 2023, down from 2.9 percent in 2021. Surging energy costs are reducing the current account surplus and feeding into to broad-based price pressures, with inflation expected to average 7.7 percent in 2022 and 4.8 percent in 2023.
Uncertainty is very high, with risks to the baseline growth forecast skewed downward and risks to the inflation forecast skewed upward. The greatest threat is a persistent shut-off of the remaining Russian gas exports to Europe, which could cause sizable reductions in German economic activity and increases in inflation. A prolonged war and resurging COVID-19 infections could also intensify supply chain disruptions. Persistently-high inflation and fears of a de-anchoring of inflation expectations can prompt major central banks to tighten policies faster than currently expected, potentially triggering a sharp tightening in financial conditions and corrections in asset prices. Over the medium term, a fragmentation of global economic supply chains related to the war could compound longstanding challenges related to decarbonization, population aging, infrastructure gaps, and digitalization.
In response to surging energy prices, the government is expanding income support for vulnerable households, cutting fuel taxes, and providing liquidity support to firms. However, the fiscal stance in 2022 is expected to be broadly neutral as COVID-19 relief measures are phased out. The debt brake rule is set to resume in 2023. To finance increased climate- and defense-related spending, the government has created extrabudgetary funds that are not bound by the debt brake rule. To secure energy supplies, the government is diversifying away from Russian oil, coal, and gas, establishing facilities to re-gasify liquified natural gas, and requiring operators to fill gas storage tanks before the winter.
The war has so far had limited effects on the financial sector. Overall, banks remain largely resilient to solvency and liquidity shocks. Since the last FSAP, the authorities have strengthened microprudential frameworks for banking and insurance, resolution planning, and crisis preparedness. However, low bank profitability remains a source of vulnerability, and stress tests identify shortfalls of capital and US dollar liquidity at some individual banks under adverse scenarios. Macroprudential institutions are well developed, and the authorities have tightened macroprudential policy this year. Nevertheless, house price valuations remain stretched and lending standards appear loose in certain segments.
Executive Board Assessment[3]
Executive Directors agreed with the thrust of the staff appraisal. They commended the authorities for their timely and well-designed response to mitigate the spillovers from Russia’s war against Ukraine, including proactively looking at contingency plans in the event of gas supply disruptions. Directors noted that growth is likely to be muted in the coming quarters, and that risks associated with a potential further disruption of natural gas supplies, a gloomy global outlook, and supply bottlenecks loom large. Inflation is also likely to remain elevated in the next two years, mostly reflecting the pass-through of recent increases in natural gas prices.
Directors agreed that the fiscal stance is appropriate for 2022, and the authorities’ plan to return to the debt brake rule in 2023 by ending COVID-19 and energy-related relief measures should be manageable. Given the high uncertainty, Directors called for maintaining flexibility and recalibrating near-term fiscal plans as needed if downside risks materialize.
Directors encouraged the authorities to continue to cushion the impact of any further sizable increases in energy prices via targeted and time-bound measures for vulnerable households, and generally recommended allowing the higher international gas prices to pass through to end-users to incentivize energy savings and facilitate the build-up of gas inventories. A few Directors saw merit in the authorities’ temporary subsidies for firm’s energy bills. Directors recommended allowing automatic stabilizers to operate fully and if needed consider activating the escape clause of the debt break rule for another year if downside risks materialize. Directors supported the authorities’ efforts to ensure energy security, including their plan to introduce financial incentives to encourage further voluntary gas conservation, and close cooperation with other EU countries in planning for potential gas shortages.
Directors welcomed the authorities’ ambitious decarbonization plans and their digitalization and transportation infrastructure push. They encouraged the authorities to continue investing in Germany’s growth potential and resilience, through further enhancing energy security, digitalization, innovation, labor supply and training, and social protection. Improving economic opportunities for women and migrants will also be important. Boosting green public investment is vital to tackle network externalities and crowd-in private investments in clean technologies, which can also help lower Germany’s large external imbalances. Directors urged the authorities to overcome the longstanding obstacles to ramping up public investment rapidly and decisively. To maintain the credibility of Germany’s fiscal framework, Directors generally stressed that structural increases in spending for strategic priorities should be integrated into the core budget over time.
Directors welcomed that the financial sector has weathered the challenging circumstances well. They noted the generally positive assessment of the resilience of the German banking system in the FSAP and broadly supported the report’s recommendations. Given pockets of vulnerability and structurally low bank profitability, Directors recommended continued close monitoring of the sensitivity of banks’ balance sheets to evolving risks and strengthening banks’ capital buffers as needed. Directors appreciated the progress in enhancing the microprudential frameworks for banks and the insurance sector and underscored the need to further strengthen BaFin’s operational independence and certain aspects of the overall supervisory framework. Some Directors suggested reviewing the design of the fragmented deposit insurance system. Directors welcomed Germany’s recent macroprudential policy tightening and underscored the need to add income-based measures to the macroprudential toolkit and expedite the closure of data gaps. Some Directors also encouraged activation of borrower-based instruments if appropriate. Continued strengthening of the AML/CFT framework will also be important.
It is expected that the next Article IV consultation with Germany will be held on the standard 12-month cycle.
[1]Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
[2]Under the FSAP, the IMF assesses the stability of the financial system, and not that of individual institutions. The FSAP assists in identifying key sources of systemic risk and suggests policies to help enhance resilience to shocks and contagion. In member countries with financial sectors deemed by the IMF to be systemically important, it is a mandatory part of Article IV surveillance, and in the case of Germany it is supposed to take place every five years. The last FSAP exercise took place in 2016.
[3]At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here:https://www.IMF.org/external/np/sec/misc/qualifiers.htm.
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