RaboResearch - Economic Research

A second blow for the German economy

Economic Comment

  • We have revised our forecast from a growth of 0.5 percent to a contraction of 4.6 percent for 2020
  • Germany corporates are better suited to absorb shocks than before the Great Financial Crisis
  • The government has let go of its fiscal prudency. A large package of measures has been announced and there is ample fiscal space to further support the economy if needed

From stagnation to a sharp contraction

At the start of the year, before the coronacrisis dominated the news and economic projections, we forecasted a moderate growth of 0.5 percent for 2020 for the Germany economy. The factors previously driving economic growth, such as an increase in the working population and consumer spending, started to slow. The manufacturing sector, with in particular the automotive sector, were still in a bad shape with no real improvement on the horizon. Our view of a small expansion (figure 1) of the economy was further supported by sentiment indicators.

Needless to say, the arrival and subsequent spread of COVID-19 has drastically changed our views (figure 2). We now project a GDP contraction of 4.6 percent for 2020.

Figure 1: The German economy was stagnating…
Figure 1: The German economy was stagnating…Source: Eurostat
Figure 2: … And should now prepare for a sharp contraction
Figure 2: … And should now prepare for a sharp contractionSource: Markit, Eurostat

Germany’s vulnerability to the crisis

In order to curb the further spread of the virus, Berlin has imposed drastic measures that constrain social and economic life such as the closure of schools and restaurants. This impacts some sectors more than others.

Demand fallout and supply chain vulnerability

Next to a direct domestic demand fallout due to the containment measures set in place, there is also a foreign demand fallout. Now that some borders are closed and the general demand for products has fallen, global trade has taken a hit. Germany is especially vulnerable for this decrease in trade since net exports account for almost a tenth of GDP. Demand shocks in China and Italy, two hard hit regions on which German exports are reliant, are especially painful for Germany.

Furthermore, due to the temporary closure of factories in for example China and Italy, German factories find themselves without sufficient stock of intermediate products to produce. Even when the containment measures in the former countries are lifted, it will take a while for factories to get up and running again and for the goods to reach German factories.

Shock absorbing capacity

In order to gauge the shock absorbing capacity of German companies and households, we look at three indicators: cash reserves, the interest coverage ratio and the profit margins of corporates. Households and corporates now hold relatively more savings than they did before the great financial crisis (figure 3), thus increasing the shock absorbing capacity. A strong suit of Germany is the interest coverage ratio. Interest payments have decreased steadily over the years (figure 4) due to low debt levels and subsequent low interest obligations. Companies will thus be able to sustain longer periods of lower revenues since their fixed cost are lower (not taking other factors such as rents etc. into account). In terms of margins, there is relatively little room for maneuver and retaining sales by cutting prices. Overall, one could say that the shock absorbing capacity of Germany has increased with respect to the great financial crisis.

Figure 3: Currency and deposits as percent of GDP
Figure 3: Currency and deposits as percent of GDPSource: Eurostat
Figure 4: Interest as percent of income
Figure 4: Interest as percent of incomeSource: Eurostat

Germany lets go of its fiscal prudency

Germany is renowned for its so-called ‘balanced-budget’ rule. It states that the government and lower governments should have a small but positive budget surplus. In recent years, many economists have called for the German government to abandon this rule so that it can profit from historically low interest rates and make some much needed investments in the economy. The German government had been reluctant to suspend it, but the coronacrisis has finally pushed the government to concede and abolish its spending constraints.

The government has announced a number of measures to combat the crisis. The package of EUR 650bn that contains EUR 600bn of state-guaranteed loans and liquidity injections for large businesses, enabling the state to take a temporary stake in struggling companies. The remainder, EUR 50bn, will be used to support ailing SMEs. Additionally, the KfW can provide liquidity for around EUR500bn.

Figure 5: Germany’s government finances are well-equipped to handle the crisis
Figure 5: Germany’s government finances are well-equipped to handle the crisisSource: Destatis

Berlin will take on a minimum of EUR 156bn worth of new debt. A part of of this amount will account for the loss in tax revenues due to lower economic activity, but the majority will be used for direct support of the economy. Examples of direct support are tax deferalls and letting off late payment surcharges. The most extensive measure, however, is the extension of the work reduction scheme, which enables employers to temporarily reduce the working hours of their employees and intends to prevent massive layoffs. The government promises these workers 60 percent to 67 percent of their pay for those reduced working hours. In the past two and a half weeks almost 500.000 companies have applied for the scheme. For comparison, in 2019 on average only 1,300 companies applied for scheme on a monthly basis. First estimates suggest that this will cost around EUR 50bn (1.5 percent of GDP). Whether these measures are enough to counter the impact of the virus remains the question, but Germany is fiscally well equipped to combat the crisis.

Erik-Jan van Harn
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 3002 0936

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