IMF mission, led by Kevin Fletcher, conducted discussions for the 2023 Article IV Consultation with Germany during May 2‒16. At the end of the visit, the mission issued the following statement

Germany: Staff Concluding Statement of the 2023 Article IV Mission

May 16, 2023

Washington, DC – May 16, 2023:

An International Monetary Fund (IMF) mission, led by Kevin Fletcher,
and comprising Ting Lan, Aiko Mineshima, Galen Sher, and Jing Zhou
conducted discussions for the 2023 Article IV Consultation with Germany
during May 2


‒16. At the end of the visit, the mission issued the following
statement:

Germany has weathered well the fallout from the Russian gas shut off,
thanks to a strong policy response and mild winter. Tighter financial
conditions and the energy price shock are nonetheless expected to keep
economic growth muted in the near term. Headline inflation is falling
steadily, but core inflation is proving to be stickier.

A top policy priority in the near term is thus to support disinflation
with a moderate tightening of the fiscal stance in 2023 as well as
supply-side reforms. At the same time, it is important that the German
authorities continue to closely monitor and address financial stability
risks, which have risen on the back of rapidly rising interest rates and
global financial market turbulence. Looking further ahead, Germany will
have to navigate a new normal that entails population aging, an ongoing
need to support efforts to combat climate change, and heightened risks of
geo-economic fragmentation. To adapt to this new normal, Germany should undertake
reforms to create fiscal space for higher public investment and rising
aging-related spending, boost labor supply and productivity, accelerate the
green transition, and enhance resilience to risks .

Recent economic developments and outlook

1.The German economy has demonstrated much
resilience over the last year. Highly adverse economic outcomes
following the Russian gas shut-off last summer—as contained in some
scenarios—have not materialized. This resilience reflects not only a mild
winter, but also impressive policy action to conserve energy, cushion the
impact of higher energy prices, and secure future energy supplies.

2.Nonetheless, tighter financial conditions and
the energy price shock have begun to weigh on near-term growth.
Financial conditions have tightened considerably, reflecting both monetary
tightening—which is necessary to reduce inflation—as well as turbulence in
global financial markets. Tighter financial conditions are weighing on
economic activity, especially in interest-sensitive sectors such as
construction of residential real estate, while the adjustment to higher
energy prices (relative to pre-war levels) is constraining output in some
energy-intensive sectors. As a result, the mission expects GDP growth to
stay near zero in 2023, before gradually strengthening to 1-2 percent
during 2024-26 as the lagged effects of monetary tightening gradually
dissipate and the economy adjusts to the energy shock. Over the longer
term, average GDP growth is expected to fall back below 1 percent due to
headwinds from population aging, absent significant accelerations in
productivity and/or labor supply growth.

3.Headline inflation is expected to continue to
subside, but core inflation is likely to decline later and more slowly. Falling
energy prices and continued normalization of supply disruptions are
expected to drive headline HICP inflation from 7.6 percent in April
down to around 4½ percent by late 2023. However, core inflation is
expected decline more slowly, given lags in the pass-through from
declining commodity prices and with the effects of rising nominal wage
pressures on prices being only partially mitigated by a moderate
pullback of recent increases in profit margins.

4.Uncertainty is high, with risks to the baseline
forecast in both directions but tilted downward. Core inflation
could remain elevated longer than expected due to higher-than-expected
stickiness and/or nominal wage pressures. This would require tighter
monetary policy, which could in turn fuel further headwinds for growth.
Renewed global banking turbulence could further increase the German
financial sector’s funding costs and tighten financial conditions, with
adverse knock-on effects for the real sector. On the upside, faster
unwinding of supply disruptions and stronger recovery in external demand
could spur faster growth.

Fiscal policy

5.The fiscal stance should be moderately tight in
2023 to support disinflation efforts. Spending on the gas and
electricity brakes is likely to be lower than budgeted in 2023 due to
falling energy prices, and fiscal revenue may also overperform. If, as
expected, the government saves these windfalls, the fiscal stance as
measured by the change in the cyclically-adjusted primary balance is
expected to turn moderately contractionary in 2023. Such tightening is
appropriate to support disinflation, with further fiscal contraction
warranted in 2024 under the baseline scenario.

6.Germany’s energy relief measures are generally
well-designed, but targeting could be improved. Germany’s main
energy relief measures—the gas and electricity price brakes—maintain strong
incentives for households and small firms to conserve energy. In addition,
many relief measures for households are income-taxable and thus
progressive. However, there is scope for further targeting this relief to
those most in need. Given administrative challenges to providing
income-based transfers for households that are not covered by the existing
social safety net, the government could consider partially offsetting the
cost of energy price relief via temporary solidarity taxes on higher-income
households or greater claw-back of energy price relief provided to them.
The gas and electricity price brakes should also be allowed to expire as
planned by April 2024 at the latest to facilitate adjustment to
structurally higher fossil fuel prices.

7.Over the medium term, Germany may need to create
more fiscal room for investing in its future. The
mission expects Germany’s fiscal deficit to narrow to around ½ percent of
GDP by 2027 as energy-relief measures phase out and the economy recovers.
Although Germany has ample fiscal space to respond to shocks, there is
hardly any room left under the constitutional debt-brake rule, which limits
annual new structural borrowing to 0.35 percent of GDP at the federal
level. Even if one assesses fiscal room against an overall deficit of
around 1¾ percent of GDP, which would stabilize Germany’s debt ratio at
around 60 percent of GDP, envisaged increases in aging-related and defense
spending leave little scope for higher public investment or addressing
other needs. To provide adequate funding for the green transition,
digitalization, and boosting human and physical capital, Germany may need
to create new fiscal room by undertaking expenditure reforms, mobilizing
additional revenue, and/or adjusting the debt brake rule (see next
paragraph). Such measures could include, for example, reforming property
taxes and/or reducing subsidies that are distortionary or environmentally
harmful.

8.Germany should consider adjusting the debt-brake
rule to better align it with EU fiscal rules and lessen reliance on
extrabudgetary funds. Germany has created multiple extrabudgetary
funds totaling about 9 percent of GDP (the Climate and Transformation Fund,
Special Defense Fund, and “Protective Shield”) while the escape clause to
the debt-brake rule was activated during the pandemic. Spending from these
funds does not count against the debt-brake limit, even if the spending
occurs after the debt-brake returns to force in 2023. However, such
spending does count toward the general government deficit as measured under
EU statistical standards. The extensive use of such funds has thus weakened
the link between the debt-brake rule and debt dynamics, as well as with EU
fiscal rules. In addition, the budget process for the special funds is less
transparent than for the core budget. To enhance transparency, cohesion with
EU fiscal rules, and the effectiveness of the debt brake, the government
should consider revising the rule to limit use of extrabudgetary funds and
increase somewhat the annual deficit limit, perhaps by 1 percentage point
of GDP. The latter change would make the rule more realistic, given
Germany’s significant medium-term spending needs, while at the same time
ensuring that debt continues to decline below 60 percent of GDP. It would
also lessen incentives to rely on extrabudgetary funds. However, such
adjustments should await the conclusion of the EU’s review of its fiscal
rules, which is nearing its latter stages, to facilitate consistency
between EU and national rules.

9.Ongoing efforts to accelerate the implementation
of public investment are welcome. Amid the energy crisis, the
government moved quickly to expand LNG terminal capacity. The 2022 “Easter
Package” also set out important measures to accelerate the expansion of
renewables. Looking ahead, the mission welcomes plans to further accelerate
public investment, including by (i) alleviating challenges from staff
shortages at the local government level by utilizing external project
managers and (ii) reforming public procurement to further simplify and
digitize procedures.

Financial sector policies

10.The overall capital and liquidity positions of
Germany’s banking system and insurance system remain sound. In
2022, banks suffered significant mark-to-market losses due to revaluation
of their securities portfolios, which temporarily lowers their
profitability. Despite these losses, the German banking system’s aggregate
capital and liquidity levels remained substantial at end-2022, with capital
at 19.2 percent of risk-weighted assets at end-2022 and liquidity coverage
ratios of 154 percent for significant institutions and 178 percent for
less-significant institutions. Germany’s substantial deposit insurance
coverage limits also support bank funding stability. Insurers similarly
suffered mark-to-market losses in 2022, but their solvency positions were
well hedged.

11.Nonetheless, financial stability risks
associated with rapidly rising interest rates should be closely monitored. Recent
bank distress in the US and Switzerland has highlighted risks associated
with excessive interest-rate exposure and unstable funding structures. The
authorities should thus continue to identify banks that are most vulnerable
to interest-rate and liquidity stress and subject them to intensive
supervision. Given elevated risks associated with macroeconomic and
financial market uncertainty, supervisors should also encourage a
conservative approach to bank capital distributions. Further enhancing
transparency around bank health by, for example, publishing additional risk
analyses, disclosing more information on less-significant institutions
(LSIs), and clarifying to the public the safety nets available could also
reduce volatility in funding conditions. Data collection and stress tests
of interest-rate risks at LSIs should also be enhanced. Meanwhile, the
authorities should encourage investment funds to continue adopting
liquidity management tools, including gates and notice periods. The
volatility of bank funding conditions also underscores the need to further
strengthen safety nets and crisis management frameworks. Toward this end,
Germany should consider simplifying the structure of depositor protection
by moving to a single mandatory scheme with a robust public liquidity
backstop. Meanwhile, resolution plans should account for the potential
joint resolution of several members of each institutional protection scheme
(IPS) and even joint resolution of an IPS member with an IPS itself.
Completion of the pan-European Banking Union and Capital Markets Union
would further enhance financial stability and economic efficiency.

12.A broader macroprudential toolkit and further
enhancing data collection would help promote longer-term financial
stability in the real-estate sector. The last decade saw rising
vulnerabilities in the real-estate market, with the share of lending with a
high loan-to-value (LTV) ratio rising until COVID-19 along with rapidly
increasing house prices.The partial correction of house
prices that began in late-2022, from overvalued levels, could push some
borrowers into negative equity. Given these risks, the mission welcomes the
higher capital requirements that took effect in February 2023. To enhance
the ability to respond to a new buildup of risks in the future, the law on
borrower-based measures should be modified to address any perceived
obstacles to their early activation and to add income-based instruments to
the toolkit. The mission also welcomes the collection, starting in 2023, of
more robust data on lending standards in residential real estate. To better
assess risks in commercial real estate, the authorities should facilitate
harmonization of definitions of lending standards across banks and collect
and publish comparable data on LTV ratios, interest- and
debt-service-coverage ratios, and debt-yield ratios.

Structural reforms

13.

Accelerating the green transition is essential to meet climate goals.

Germany met its 2022 CO2 emission target thanks to a sharp decline in
emissions by industry and favorable weather. But continued efforts are
needed to meet targets going forward. Toward this end, the government should
resume the increase in domestic carbon pricing in 2024 as planned and
consider further strengthening it. Take-up of existing programs that
support the green transition could also be enhanced by simplifying
procedures and ensuring cohesion across programs. Meanwhile, any additional
subsidies for the green transition should be limited to addressing market
failures and be fiscally affordable both in Germany and other EU countries,
as single-market principles require a consistent approach across countries.
Accelerating the expansion of EV charging stations and the smart grid
network is critical, and revenue-neutral feebate schemes could further
speed the green transition. The mission welcomes the introduction of the EU
Carbon Border Adjustment Mechanism, which reduces carbon leakages, as well
as Germany’s leadership in creating the Climate Club, which aims to provide
an inter-governmental forum for discussion, cooperation, and coordination
on climate-change mitigation policies.

14.

The government is making welcome efforts to boost Germany’s human
capital, including by increasing immigration and support for worker
training.

Plans to augment the Skilled Immigration Act should help dampen the
projected decline in the labor force due to population aging. The recently
passed Bürgergeld also includes, among other elements, training initiatives
that aim to help the unemployed find better-paying jobs. It will be
important to closely monitor the use of Bürgergeld and adjust its design if
needed to ensure that it achieves its objectives and does not unduly
lengthen unemployment spells.

15.Boosting labor productivity by further
enhancing capital deepening and innovation is also essential to lift
economic growth.
Germany is an innovation leader in Europe. That said, Germany’s labor
productivity growth has declined over the last decade and trails
non-European advanced economies. Germany’s relatively low labor
productivity growth is driven mainly by lower ICT capital deepening and
weaker multifactor productivity. At the same time, new business
registrations have trended downward. To lift productivity, Germany should
(i) enhance incentives to undertake R&D, including by expanding R&D
tax credits and increasing the availability of qualified workers; (ii)
expand funding for young and innovative firms by reducing barriers to the
participation of institutional investors in venture capital markets and by
aligning the tax treatment of stock-ownership option plans with
international standards; and (iii) lower market entry barriers for such
firms, including by increasing use of digital government, reducing
administrative red tape, and strengthening the competition framework.

16.Germany should assess and prepare for risks
related to geo-economic fragmentation (GEF) while pursuing structural
reforms to increase its attractiveness as an investment destination. Intensified
global geo-political tensions have raised GEF-related risks. Extensive
and broad-based GEF could increase output losses and financial
instability, as cross-border trade, knowledge flows, and investment
become more costly. Germany and its trading partners should therefore
continue to support a multilateral, rules-based trading system that
promotes mutually beneficial cooperation on trade and cross-border
flows. At the same time, Germany should identify its critical
dependencies, assess the impact and transmission channels of different
GEF scenarios (e.g., stress tests of value chains), and develop
strategies for coping with risks. Structural reforms, as outlined in
previous sections, would also help retain Germany’s attractiveness as
an investment destination.

***

The mission team thanks the authorities andall our other
counterparts

for their warm hospitality and for the constructive dialogue and
productive collaboration.

IMF Communications Department

MEDIA RELATIONS

PRESS OFFICER: Camila Perez

Phone: +1 202 623-7100Email: MEDIA@IMF.org

@IMFSpokesperson