Euro Area—IMF Staff Concluding Statement of the 2019 Article IV Mission
June 13, 2019
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
The euro area is at a challenging juncture. Growth is expected to
firm-up later this year but there are significant risks to this
outlook. Greater structural reforms efforts at the national level would
enhance the region’s resilience. In the event of a sharp downturn
additional policy support will be needed. While there is some progress
on euro area reforms, in many cases political consensus on the path
forward is missing. The incoming European Parliament and European
Commission should use the opportunity to forge a renewed consensus
around strengthening the foundations of the monetary union.
Outlook and Risks
Euro area growth has slowed and inflation continues to disappoint. Growth decelerated sharply in the second half of 2018, due to a
combination of slowing external demand and mostly temporary domestic
factors. While headline inflation has fluctuated with energy prices, core
inflation has remained troublingly low despite declining unemployment and a
gradual pickup in wage growth.
Growth should firm up over the course of this year, but inflation will
take longer to pick up. The growth projection is premised on continued robust
domestic demand on the back of a tight labor market, a global recovery and
continued monetary accommodation. Inflation, however, is forecast to reach
the ECB’s objective only gradually, reflecting subdued core inflation.
Little progress has been made on reducing imbalances. The euro area current account surplus has narrowed
slightly, but it is still assessed by IMF staff to be moderately stronger
than warranted by fundamentals. This is primarily driven by a few countries
with sizable current account surpluses.
The central forecast is precarious, with three serious risks that could
derail the upswing. First, prolonged global trade tensions could undermine external demand.
Second, the risk of a no-deal Brexit remains high; while the financial
sector has made progress in preparing for this eventuality, firms in other
sectors—especially smaller firms—are less prepared. Third, high-debt
countries’ failure to rebuild fiscal buffers and implement structural
reforms leaves them more vulnerable to shifts in market sentiment and the
next downturn. These risks could materialize synchronously. Even without a
major shock, the euro area could experience a prolonged period of anemic
growth and inflation.
Monetary and Fiscal Policy
The persistent undershooting of the inflation objective calls for
prolonged monetary accommodation, although this is not without
risks. The ECB’s stance is already accommodative, and the recent further
extension of its forward guidance should support a sustained pickup in
inflation. Keeping rates lower for longer is not without risks though. The
heterogeneity in cyclical conditions across euro area countries implies
that a prolonged period of further accommodation could contribute to the
emergence of financial stability risks in countries with positive output
gaps. Macroprudential policy tools should be actively deployed to help
contain these risks. If the inflation outlook is downgraded further, even
greater accommodation will be needed.
Better compliance with and enforcement of the fiscal rules is
needed now. Despite robust growth in recent years, high-debt countries have not
sufficiently consolidated, and in some cases have even eased fiscal policy.
Yet, these deviations have been met by lenient enforcement, weakening
countries’ incentives to respect the rules and making it hard for the EU
institutions to credibly react to new violations.
Countries with limited fiscal space should prioritize debt
sustainability, while those with ample space should use it to lift
potential growth. Even with growth slowing in the baseline, high-debt
countries should rebuild fiscal buffers in case the growth outlook worsens
significantly, including through a more growth-friendly composition of
fiscal policies. Countries with ample fiscal space should take advantage of
low borrowing costs to invest in potential growth-enhancing areas, such as
infrastructure, innovation and education.
Should growth deteriorate sharply, a more active fiscal policy response
will be needed. If the euro area is tipped into a recession, the escape
clause in the fiscal framework could be activated, allowing countries to
use fiscal policy to support growth, while being appropriately
differentiated according to national fiscal space, financing conditions,
and the severity of the downturn. Fiscal policy should become more
expansionary through temporary, high-quality measures in countries with
fiscal space. Fiscal consolidation could be slowed down temporarily in
countries where fiscal space is at risk, provided that their financing
conditions remain amenable and debt sustainability is not jeopardized.
More demand will not fix deep-seated productivity and competitiveness
problems in some countries; these require more decisive structural
reforms. Product and labor market reforms are
critical to closing productivity and competitiveness gaps between euro area
countries. Such reforms would most benefit those countries with lower
productivity levels. Critically, at a time when risks loom, reforms would make economies more resilient, lessening
the depth and duration of downturns.
The new Commission should reinvigorate the push to fully implement the
EU Services Directive. The single market for services lags far behind the EU’s
substantial accomplishment in creating a single market for goods. Better
implementation of the EU Services Directive has the potential to boost
productivity and cross-border trade in services. This can be done through
focusing on the services sector in country-specific recommendations and
stepping up enforcement of the Directive. The next EU budget also provides
an opportunity to provide more financial and technical support for reforms.
The EU has been laudably proactive in safeguarding gains from
international trade. Increasing economic prosperity through economic integration is one of the
cornerstones of the EU. We welcome the EU’s initiatives to reform the World
Trade Organization to address its current weaknesses.
Further strengthening the banking sector is also critical to making the
euro area more resilient. While banks have boosted capital buffers and made
progress on reducing nonperforming loans, low bank profitability remains a
pervasive concern throughout much of the euro area. Supervisors should
continue to assess banks’ business models critically, pushing for greater
revenue diversification and cost efficiency, including through cross-border
mergers and acquisitions.
The authorities are making a determined effort to tackle the 2018
Financial Sector Assessment Program (FSAP) recommendations,
although in some areas progress is slower than hoped. In line with FSAP advice, the Single Supervisory Mechanism (SSM) is
monitoring liquidity more closely and has begun using its early
intervention powers to deal with problem banks. While the reviews of the
bank supervision and resolution frameworks have been delayed until the next
Commission, the SSM has begun developing an action plan to reduce legal
fragmentation in supervision that will inform the review. The new
Commission should use the reviews to reduce legal fragmentation and enhance
the toolkits of the supervisory and resolution authorities, as recommended
by the FSAP. Recent money laundering cases have highlighted the need to
centralize anti-money laundering (AML), which is also fragmented along
national lines. The SSM’s new AML coordination function, which acts as a
central point of contact and information exchange for systemic
institutions, is welcome. Over the medium term, an EU-level AML body should
be established, consistent with FSAP advice.
Euro Area Architecture
The euro area needs a truly borderless banking market but getting there
will require more ambitious steps. The agreement on the European Stability Mechanism
providing a backstop to the Single Resolution Fund is welcome, but the
final design must allow for rapid deployment of the backstop in a crisis.
Ring fencing of capital and liquidity at the national level impairs the
development of the banking union yet reflects legitimate home–host tensions
on burden-sharing when banks fail. Addressing this will require creating a
common deposit insurance scheme with due attention to risk reduction. The
next Commission should seek to reenergize this effort.
The new Commission should also push to develop the Capital Markets
Union (CMU). Capital markets in Europe remain fragmented, impeding
cross-border private sector risk sharing. Relatively technical actions
would advance the CMU. For example, centralized reporting requirements for
companies would improve transparency, while minimum standards on insolvency
regimes and simplified procedures for reclaiming withholding taxes would
reduce cross-border investments’ costs.
The euro area also needs an additional macroeconomic stabilization
instrument. As we proposed last year, a central fiscal capacity
could enhance the region’s resilience to shocks. However, reaching
agreement on such an instrument is likely to take time. Though the details
of the proposed euro area Budget Instrument for Convergence and
Competitiveness have not been determined yet, it is an encouraging
acknowledgment of the need for a euro area-level fiscal instrument.
A simplification of the fiscal rules would make them easier to
communicate, monitor and enforce. We favor focusing on an expenditure growth rule anchored by a debt rule.
Agreeing on how to revamp the fiscal rules will not be easy, but the next
Commission should not shy away from it.
The next EU budget offers leaders and the incoming European Parliament
a chance to demonstrate their ingenuity in addressing priority issues. Brexit will result in the loss of the U.K.’s net contribution to the EU
budget for 2021–27. This could be tackled with a mix of new revenue sources
and streamlining of some expenditures. The next budget should also be
reoriented to better address critical priorities such as climate change,
innovation, migration, and security.
Strengthening the architecture and addressing common challenges will
require creative cooperation. And given the imminent risks facing the euro area,
governments should do more to reduce imbalances and increase economic
resilience at the national level.
IMF Communications Department
PRESS OFFICER: Andreas Adriano
Phone: +1 202 623-7100Email: MEDIA@IMF.org