RaboResearch - Economic Research

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COVID-19 pushes Germany into recession

Economic Report

  • At the end of 2019, the German economy stagnated and was underperforming compared to its peers
  • Early 2020 figures looked hopeful but the outbreak of the COVID-19 virus has led us to reduce our growth projections for Germany. We predict a recession in the second quarter of 2020
  • Germany is particularly vulnerable to the virus due to its large manufacturing sector, dependence on trade with China and Italy and shock-absorbing capacity of non-financial corporates
  • Berlin has announced a number of policies to aid ailing businesses. Moreover, extra government investments are supposed to prop up the economy. We expect additional supporting measures if the situation worsens

A second blow for the German economy

In the fourth quarter of 2019 the German economy stagnated (figure 1). The factors that drove German growth in the past year, such as an increase in the number of working people, have come to a halt. The external environment has not been supportive either. Weak demand from China and other Asian countries impacted performance in the German manufacturing sector and in particular the large automotive industry. For 2020 we projected a moderate growth of 0.5%. Confidence indicators at the end of the 2019 supported this case (figure 2): both PMIs and the Ifo business confidence indicator pointed at a modest expansion.

Just when the manufacturing sector was finally able to report some positive figures, the COVID-19 virus arrived in Europe and spread like wildfire in Italy. It is inevitable that the virus will spread further within Europe and that the number of confirmed cases continues to rise. Therefore we have significantly changed our forecast. We now project a recession in Germany in the second quarter of 2020 and an overall growth of -0.3% for 2020. 

Figure 1: The Germany economy stagnated at the end of 2019
Figure 1: The Germany economy stagnated at the end of 2019Source: Macrobond, RaboResearch
Figure 2: Sentiment indicators indicate a moderate growth. The COVID-19 effect is not yet included
Figure 2: Sentiment indicators indicate a moderate growth. The COVID-19 effect is not yet includedSource: Markit, Ifo

A slump in domestic demand

Domestic demand will be hit through a combined supply and demand shock. The supply shock works through a number of channels, some of which will be discussed further on. One of these channels is labor supply. When the number of employees that are ill or put in quarantine increases, the supply of labor falls. Moreover, remote-working and the cut back in, for example, ‘non-essential business travel’ reduces efficiency. If the number of cases rises further the government could decide to put entire regions in lock down (as the Italian government has done in Lombardy) which would further limit the possibility for people to work uninterrupted.

Secondly, the demand side is shocked. The ban on large events, companies restricting travel and a general fear of going out reduce the demand for services and goods. Especially companies such as trade fair operators, hotels and companies operating in the tourism business are affected[1]. Consequently, businesses tend to postpone their investments due to uncertainty about the timing of the turning point in the epidemic.

An extra complicating factor is that a fallout in demand and supply is not easily averted through fiscal or monetary policies. Lowering taxes or interest rates does not make people want to go out more if they are afraid to catch a disease. Neither does a tax break cure sick employees. The only way to revitalize domestic demand is through taking away uncertainty and fear. This is, with something as hard to control as an epidemic, easier said than done. Revitalizing the supply side of the economy will be even harder to achieve.

A double dip in foreign demand

The vast majority of current COVID-19 cases are currently in China (70%), Italy (8%) and South-Korea (7%)[2]. These economies are feeling the pinch of the containment policies and the unrest that affects business investments and consumer spending. Since Germany exports a significant amount of goods and services to these countries, a slump in demand abroad will directly affect the demand for German goods and services.

Especially the German automotive sector will be hit by a drop in demand. China is a key market for the German automotive industry but car sales in China have been in a complete free fall (figure 3). It is no wonder that, given the fact that the German automotive sector is already under a lot of stress (figure 4), 10 out of 12 German carmakers have issued profit warnings. On average the new profit targets, with 37%, have been significantly reduced.

Figure 3: Car sales in China are in a free fall (shaded area is COVID-19 period)
Figure 3: Car sales in China are in a free fall (shaded area is COVID-19 period)Source: China passenger car association
Figure 4: The German automotive sector is already under stress
Figure 4: The German automotive sector is already under stressSource: Destatis

Vulnerable supply chains

The sharp contraction in economic activity and business confidence in for example China (figure 5), will hit Germany directly through a decrease in trade but also through the channel of disrupting supply chains. Supply chains in for example the manufacturing sector often span across multiple countries. Since some of these supply chains are optimized to have the minimal inventory, a disruption somewhere in the chain immediately frustrates the subsequent steps in the production process.

Germany’s industry is reliant on intermediate products from China and Italy, two hard-hit regions. Together these countries account for a large part of intermediate imports by German industry (figure 6). Now that operations in several factories in China and Italy have been suspended, multiple companies are starting to experience the supply chain disruption. Chinese exports for example, decreased by 17% over January and February.[3] The gravity of this effect is amplified by the fact that China plays a so-called ‘forward’ role in the supply chain vis-à-vis Germany. A lack in supply of (intermediate) goods leads to a decrease in inventories. Companies facing low inventory levels either have to decrease their output or find alternative suppliers (usually at higher cost).

Figure 5: Business confidence in China has plummeted (shaded area is COVID-19 period)
Figure 5: Business confidence in China has plummeted (shaded area is COVID-19 period)Source: Markit
Figure 6: Import origin of intermediate goods for Germany
Figure 6: Import origin of intermediate goods for GermanySource: OECD statistics (2015)

Are German companies able to take a hit?

Next to a direct drop in foreign demand and the disruption of supply chains, an increase in the number of COVID-19 cases directly affects the supply and the demand side of the economy. The supply side is affected through an increase in sick leave and quarantine policies whereas the demand side is affected through a decline in for example consumer spending and business investments.

In order to estimate the shock-absorbing capacity of German companies we look at a number of ratios:

  • The amount of cash and deposits held by non-financial corporations
  • The interest coverage ratio[4]. As a rule of thumb, a ratio lower than 2 indicates that a company is in trouble
  • The profit share as percentage of GDP. This measures the ability to temporarily decrease margins without losing market share

German non-financial corporations have relatively small cash reserves compared to their European peers (table 1). Since over half of all German companies expect their revenues to shrink this year, this is troublesome. The interest coverage ratio on the other hand is very strong. This is the result of low interest rates and low debt ratios. Lastly, the profit share is relatively low as well.

Table 1: Financial shock-absorbing capacity
Table 1: Financial shock-absorbing capacityNote: Given the relatively high heterogeneity between financial shock absorption indicators, we caution against drawing strong conclusions from this heat map.
Source: Macrobond, RaboResearch

All in all, the relative ability of Germany non-financial corporations to withstand the potential economic downturn of the COVID-19 virus is not very robust, albeit significantly better than during the Great Financial Crisis (figure 7,8). The government could support companies by providing liquidity in the short term to absorb a decrease in income when necessary.

Figure 7: Currency and deposits % GDP
Figure 7: Currency and deposits % GDPSource: Eurostat
Figure 8: Interest as percent of income
Figure 8: Interest as percent of incomeSource: Eurostat

Berlin is ready for more action

On the 8th of march, the German government agreed on new aid measures and policies related to the Corona virus. First of all, Jens Spahn, the German health minister, stated that gatherings of more than 1,000 people should be scrapped. The government will aid companies operating in this field to cushion the blow.

Additionally, it will be easier for companies that need to cut working hours for their employees due to the crisis. Companies can apply for subsidized ‘Kurzarbeit’ funds when a tenth of their workforce is affected by the virus, down from a third of their workforce earlier. Berlin also pledged to come up with plans to offer additional liquidity for affected companies.

Moreover, the government has agreed on a big aid package for the Germany economy. Government investments will be boosted by a yearly EUR 3.1 billion between 2021 and 2024. These extra investments are financed from the 2019 budget surplus that was historically high at EUR 13.5billion. These extra investments would be invested in infrastructure and affordable housing.

Figure 9: Germany’s public finances are healthy
Figure 9: Germany’s public finances are healthySource: Destatis

We expect that Berlin will keep a close eye on the developments and stand ready with extra stimuli if necessary since there is ample room to do so (figure 9). Historically low interest rates and prudent budgets have improved Germany’s debt position significantly over the past few years. And with Chancellor Merkel’s party at an all-time low in the polls, it is in her and her party’s interest to show Germany that they can handle this crisis. And with a rising chorus of calls for fresh central bank support, the German government is likely to have a strong incentive to act now, given the skeptical views with regard to monetary policy in the country. So failure to act by the government would only serve to further undermine its credibility in this time of crisis.


[1] The tourism branch only makes up 8.6% of GDP (WTTC, 2018).

[2] Source: Johns Hopkins CSSE (March 10).

[3] Note that the export volume was reported for January and February as a whole; the total of January and February was thus 17% lower than the total of November and December.

[4] The interest coverage ratio is defined as: earnings before interest and tax / interest expense

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

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