1. The German recovery is expected to gain further momentum and keep outpacing that in the rest of the euro area. Germany remains an anchor of regional stability. Balance sheets are generally healthy, fiscal consolidation has been broadly achieved underpinning confidence, and financial conditions for enterprises are favorable. Private consumption should benefit from solid wage and employment growth, while business investment should continue to strengthen. However, while domestic demand is expected to contribute to growth more than in the past, the decline in the current account surplus is projected to be gradual. Risks to the outlook are broadly balanced. The main upside risk stems from the possibility of a long-awaited and stronger-than-expected rebound in private investment. Downside risks include faltering growth in the rest of the euro area, where domestic demand is constrained by the need to repair balance sheets both in the private and the public sectors, at a time when high unemployment and low and declining inflation are hampering the repair process. A sharp slowdown in emerging markets would negatively affect German exports, while an escalation in geopolitical tensions surrounding Ukraine would likely hit investment by increasing uncertainty and hurting market confidence.
2. Policies should focus on increasing growth in Germany while at the same time supporting the recovery in the euro area. Higher public and private investment and services sector reform in Germany would raise medium-term output, reduce the large and persistent current account surplus, and generate appreciable positive demand spillovers to the rest of the euro area, thus helping rebalancing within the monetary union. In a broader context, Fund staff have also called for more accommodative monetary conditions to support the regional recovery.
3. Stronger public investment, particularly in the transport infrastructure, is needed and feasible. The government’s decision to boost spending in this area is welcome, but the amount is small relative to estimated needs. Additional investment up to 0.5 percent of GDP per year over four years could be financed without violating fiscal rules and would have only a minor impact on the debt-to-GDP ratio given the growth offset. Such a program would yield a persistent increase in GDP by crowding in private investment and would also stimulate growth in the rest of the euro area. Measures to ensure that the financed projects have true economic value need to be put in place. It would also be important to explore the role that the private sector could play in these initiatives through public-private partnerships.
4. Unlike spending on investment, pension expenditures do not increase potential output, and have negligible outward spillover effects. Planned increases in benefits to certain categories of pensioners are particularly costly. Measures to facilitate early retirement for workers with long contribution periods will likely reduce older workers’ labor market participation and add to skills shortages in some sectors, while further increasing already high social security contributions down the road.
5. Greater clarity about the future energy sector regulatory framework would encourage private investment. While the goals of the Energiewende are clear, there are implementation challenges. Surveys indicate that uncertainty about energy policy has been discouraging investment by firms outside the energy sector. The announced reform of the renewable energy law has usefully clarified important elements of the strategy, including – for the short term – the contentious regime of exemptions for energy-intensive, internationally-active firms. However, the private sector still perceives the exemption regime in the medium-term as uncertain. At the same time, hostility by some affected parties continues to delay the needed grid extension. Estimates of investment needed to upgrade the energy infrastructure are about 1-1½ percent of GDP per year until 2020. Mobilizing this investment potential would help strengthen the outlook.
6. Further reforms in services sector regulation could boost competition and productivity. There is scope for deepening competition in several areas of the services sector. In professional services (accountants, architects, engineers, lawyers, tax consultants, etc…), greater flexibility could be introduced in the areas of exclusive rights, compulsory chamber membership, and regulation on prices and fees. While barriers to competition are generally low in network industries, in rail transportation and postal services we would welcome the reinforcement of the regulator’s powers to stop discrimination against the incumbent operators’ competitors.
