IMF Executive Board Concludes 2021 Article IV Consultation with Germany

Washington, DC: On July 14, 2021, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1]with Germany.

Germany weathered the first wave of the COVID-19 pandemic relatively well. The economy contracted by 4.8 percent in 2020, outperforming most European peers. But new waves of infections—marked by more transmissible virus variants—and associated lockdown measures compounded by supply-side shortages caused economic activity to contract again at the beginning of the year. Mass vaccinations were slow to start but have gathered pace. In 2020, Germany recorded its first fiscal deficit in eight years, reflecting unprecedented policy support to combat the pandemic. The current account surplus narrowed slightly relative to 2019, with the contraction in the goods trade balance largely offset by a commensurate decline in the services deficit and lower oil prices.

Fiscal and financial policies remain accommodative, and most measures supporting households and firms have been extended through 2021, enabled by the continued activation of the escape clause to the debt brake rule. The expansion of short-time work benefits (Kurzarbeit) has played a crucial role in preserving jobs and supporting domestic demand. Following a brief spike at the onset of the pandemic, credit growth eased through the remainder of 2020. German banks have so far weathered the COVID-19 shock relatively well, as the number of business and household insolvencies have remained subdued, aided by fiscal support measures and insolvency moratoria. However, the gradual unwinding of policy support could lead to rises in loan impairments and provisioning requirements, and large segments of the banking sector still struggle with persistently low profitability.

Staff expect growth to gather strength as vaccination becomes widely available and the economy reopens. However, the outlook remains highly uncertain, with further infection waves and mobility restrictions comprising the chief source of risks. Over the medium term, structural changes ushered in by the pandemic could compound longstanding challenges related to population aging, infrastructure gaps, digitalization, and the green energy transition.

Executive Board Assessment[2]

Directors commended the German authorities for their decisive policy actions, enabled by Germany's ample fiscal space, as well as their global efforts, via the COVAX initiative, to fight the COVID-19 pandemic. They noted that a robust recovery is expected in the second half of 2021 as mass vaccinations gather strength, although large uncertainties remain. In this context, Directors underscored that supportive policies should continue, and as the recovery strengthens the focus should shift to addressing long-standing structural challenges.

Directors emphasized that fiscal policy should remain supportive until there is clear evidence of a sustained recovery, while encouraging the frontloading of public investment. To facilitate post-crisis resource reallocation, they stressed that a carefully calibrated fiscal support withdrawal should be accompanied by well-targeted measures. Directors noted the merits of Germany's short-time work program (Kurzarbeit) to contain the impact on unemployment and support aggregate demand, but stressed the importance of additional measures targeted at groups hard hit by the pandemic and not covered by Kurzarbeit, to prevent widening inequality and deeper labor market scarring. Looking ahead, Directors called for Germany to use its fiscal space to scale up public investment to lift potential growth, facilitate structural transformation, and help address Germany's large external imbalances.

Directors supported the authorities' structural reform agenda to boost potential growth and support a green and digital transformation. They welcomed Germany's strong commitment to fighting climate change and further enhancing the multi-pronged climate action plan. A well-specified schedule of carbon prices over a longer-term horizon would enhance efficiency. Directors also noted that the pandemic has increased the urgency of the long-standing need for a digital transformation and greater innovation. They encouraged the government to accelerate the expansion of high-speed broadband networks, increase support for R&D, promote further venture capital, and improve the business environment.

Directors stressed the need to safeguard financial stability during the nascent recovery. In light of the risk of rising bankruptcies as support measures are phased out, they recommended continued targeted liquidity and solvency support for viable firms. Directors also highlighted the need for banks to improve their cost structures to address the chronic low profitability of Germany's banking sector. They welcomed the authorities' efforts to address remaining data gaps and stressed the need for closely monitoring the buildup of financial vulnerabilities in real estate markets. Directors looked forward to the recommendations from the ongoing 2022 FSAP.