Country Report Germany
The German economy performs well on the back of improved domestic demand and a competitive export sector. The public sector is effective in reducing debt. The housing market in the big cities remains buoyant, but is moderating slowly.
Strengths (+) and weaknesses (-)
(+) Competitive export sector
Germany’s export position profits from a combination of wage moderation over a prolonged period, strong productivity growth and high world demand for its products.
(+) Large, positive, net international investment position (NIIP)
As a result of its competitiveness, Germany has had a current account surplus since 2002, which averaged around 6% of GDP over the last 10 years. This results in a large NIIP (46% of GDP in 2012).
(+) Stable public finances
Although the public debt is still above the 60%-threshold, it is on a steep downward path. This is due to the conservative fiscal policies. For the future, these are reassured by the debt brake rule that prohibits large structural deficits and will come into force in 2016.
(-) Ageing population
Germany’s working age population has declined since 1998. The expected further ageing of the population will put a strain on government finances and growth perspectives in the medium-term.
1. Economy is performing well
Real GDP growth increased to 1.6% in 2014, after 0.2% in 2013. Economic activity has not been buoyant during the whole year, however. Especially in the first and the last quarter growth was strong. Both net exports and domestic demand supported the economic activity (figure 1). Going forward, we expect a strengthening of growth to 1¾% in 2015 and 2% in 2016. In both years, the forecasted GDP growth is above potential GDP growth (1.5% according to the European Commission). Compared to the previous years, we expect growth to become increasingly domestically driven. The private consumption outlook is favourable as households’ spending power improved because of a solid average wage growth (2.9% y-o-y in 2014Q4) and a decline in inflation due to a lower oil prices. The introduction of a minimum wage has improved the income of the households with the lowest earnings, while it does not yet have an impact on employment. Private investment will once again be deferred due to increased risks, both in the eurozone (in Greece) and just outside (in East Ukraine for example). This will limit the growth of investment in the initial quarters. Over the longer term, rising demand both internally and abroad, in combination with relatively high levels of capacity utilisation will lead to increased investment. Exports will be supported by an expected increase in economic growth in the major trading partners and the lower euro.
2. Government finances are healthy
The German federal government achieved a balanced budget, against expectations of a EUR 6.5bn deficit. The structural budget balance was slightly positive in 2014 (0.3% of GDP). For 2015, the German Ministry of Finance also presented a balanced budget. Germany benefits from low interest rates, which help lower sovereign borrowing costs in the medium term. The yields on German government bonds with terms to maturity of 6 years or less are now negative. As a result, government debt is declining quickly, IMF expects debt to be at 60% of GDP in 2019 (down from 74% of GDP in 2014).
3. Low interest rate environment challenges the stability of the financial sector
Both banks and insurance companies face problems due to the low interest rates. It puts pressure on the earnings of the banks. The net interest income will be reduced when loans with a higher yield are rolled over in lower-yielding ones. Lower lending rates can barely be compensated by lower deposit rates, the current average interest rate on overnight deposits is only 0.2%. In the insurance sector, the situation for life insurance providers is the worst. They have high guaranteed payments, while otherwise interest rates are low or even negative. Accordingly, this results in a lower solvency ratio, amid the change towards stricter regulatory capital requirements (Solvency II). The Bundesbank performed a stress test on the life insurers. In the milder version (government bond yields follow the historical path of the Japanese yields), 12 of the 85 insurance companies will be insolvent by 2023. In the more severe scenario, in which the excess return shrinks by 25% permanently, 32 companies would become insolvent.
4. Search for yield supports buoyant equity- and housing markets
The low interest rates in the eurozone have promoted a search for yield. The additional liquidity due to the ECB’s quantitative easing programme has strengthened this development. This resulted in sharply rising prices in both the equity market and parts of the housing market. The stock market index (DAX) increased by 21% over the 3 months up to March 2015 (compared to a 2% total increase between Jan 1st 2014 and Jan 1st 2015). The upwards trend of German house prices continued in 2014 (figure 2). This has been primarily driven by the strong house price growth in the seven biggest cities that, however, did slow down to 5.8% in 2014 (7.6% in 2013). There are no signals yet that mortgage lending growth (around 2.5% countrywide in 2014) accelerated in these areas. According to a Bundesbank survey, the amount of high LTV-lending (above 100%) is high (around 1/3 of all new lending) and increasing in these cities. The risks are, however, mitigated by that households are choosing a higher amortization rate than before. This reduces the maturity of new lending from approximately 28 years to 23 years. Moreover, the fixed interest period is increasing slightly, which makes households less vulnerable to a sudden interest rate increase. Whereas the Bundesbank estimates that house prices in the biggest cities are overvalued by about 25%, the fundamentals do not indicate overvalued house prices countrywide. The price-to-rent ratio was 90.3, while the price-to-income ratio was 85.2. For both ratios, the historical average is 100.
Germany is the fourth-largest economy of the world. Its economic growth has been primarily driven by exports during the last decades. After the reunification a strong wage increase led to a deterioration of export competitiveness, which got Germany the nickname ‘the sick man of Europe’. Through a long period of wage moderation and productivity increases, competitiveness has been restored. Nevertheless, the country suffered a severe recession in 2009. The recovery was stronger than in most other countries, due to high demand for their export products (especially cars) from emerging markets (especially China). Unlike in other eurozone countries, unemployment decreased between 2007 and 2013 and that is often attributed to the labour market reforms (Hartz) of 2003. Gross private sector debt (110% of GDP in 2013) is among the lowest in the eurozone, which makes private sector deleveraging unnecessary. Although the public debt is still above the 60% of GDP threshold (74% of GDP in 2014), it is on a downward path (reaching 60% of GDP in 2019 according to the IMF). The debt brake rule that forbids the government to run a structural deficit in excess of 0.35% of GDP from 2016 onwards ensures that the fiscal position will not deteriorate in the future. A long-term challenge for both economic growth and the public finances is the ageing population. The primary pension is a state pension (78% of total pensions), which is a pay-as-you-go system that will be difficult to finance with a rapidly ageing population. The banking sector has assets equal to about 309% of GDP and a large amount of banks can be separated in roughly three sectors, private sector banks (39%), public sector banks (including Sparkassen and Landesbanken) (28%) and cooperative & mortgage banks (21%). The domestic exposure is fairly concentrated in mortgages. After the Global Financial Crisis, the banks increased their capital buffers.