Growth Threats

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For Germany's Reliable Economy, a Cloudy Forecast

Bundesadler --- Image by © Matthias Kulka/Corbis
                                                                 Is the German eagle getting rusty?
  • Why it matters

    Why it matters

    The German economy has long carried much of the crisis-torn euro zone on its shoulders. But that could be coming to an end.

  • Facts

    Facts

    • Germany’s economy contracted 0.2 percent in the second quarter.
    • The Ukraine crisis has caused German exports to Russia to plummet.
    • German companies can no longer rely on China as source of growth.
  • Audio

    Audio

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Germany is steaming ahead, and pulling the rest of the sickly euro zone with it. That’s been the accepted wisdom in Europe ever since the international debt crisis rocked the continent in 2009. With problems worsening in France and Italy, the euro zone has relied more and more on its largest economy. But what happens when the German engine starts to stutter?

The European Commission in Brussels has not wanted to envision this terrifying prospect. Even in its last forecast in May there was a lot of hope placed on Germany’s broad shoulders.

“We expect that economic growth will accelerate, driven by the domestic demand,” the forecast stated. German exports would grow “dynamically” again, capital investment would pick up and consumption would remain “robust.” The report predicted the German economy would expand by 1.8 percent this year.

 

Stagnating Europe-01

 

1. Europe’s economy is stagnating

It has become exceedingly clear that growth will be much worse. The fact that German gross domestic product contracted unexpectedly in the second quarter has caused anxiety in Brussels.

“The disappointing German and French GDP data for the second quarter underscore the need for accelerating structural reforms,” said a spokesman for Jyrki Katainen, the new European commissioner for economic and monetary affairs and the euro.

Mr. Katainen’s spokesman said that Germany must “increase public investment in infrastructure, education and research and support domestic demand.” Essentially, that means that Germany should, for example, lower the tax burden on low-income workers.

The German government is being asked not only to do more at home to spur economic growth, but also at the European level. Jean-Claude Juncker, the designated European Commission president, called in his acceptance speech recently for a new European investment program of €300 billion ($394 billion).

That demand is being echoed by European Central Bank President Mario Draghi, who has said that a public E.U. investment program “appears to be necessary.”

While French President François Hollande backs the idea, German Chancellor Angela Merkel has remained conspicuously quiet on the issue. But for how much longer? “She’ll have to address the looming collapse in growth soon,” said Sven Giegold, a German in the European Parliament for the Green party.

 

2. Germans aren’t investing enough

This year was actually supposed to be the year in which Germans finally started to make sizable capital investments – at least according to forecasts made last spring. The deficit left over from the past two years, when investments in fixed assets fell and squeezed the country’s economic performance, was supposed to narrow. A survey by the Ifo Institute found that two-thirds of German industrial companies wanted to spend more in 2014.

But now it looks as if that won’t happen after all. Following the outbreak of conflicts in Ukraine and Iraq, there is growing doubt about the German economy and how stable it still is.

The natural reaction to such rising insecurity swiftly followed: first industrial orders fell, and then production dropped. Investment in the second quarter in Germany even declined from previously low levels, according to the Federal Statistics Office. And above all there was less construction activity.

Things look slightly different for public building projects. Most of the investment here is based on budgetary considerations, and that is not bad in many places in Germany. The federal government, the states, and especially municipal authorities are increasing investment here and there. However, the combined share of the state is too small overall to break the cyclical weak investment.

 

3. Consumer confidence could soon tip

The hopes of most economists in Germany are all currently pinned on buoyant domestic demand. And on first glance, it really looks as if German consumers will continue to spend. However, the GfK consumer confidence index recently started falling from an almost eight-year high.

But the survey doesn’t really paint a complete picture of reality. Last year, as the indicator began its rise, consumption rose a mere 0.5 percent, according to the Federal Statistics Office. And in the second quarter of 2014, private consumption was not enough to bolster growth. Instead, Europe’s largest economy shrank from the previous quarter by 0.2 percent.

But consumption is still propping up the German economy, if only because gross wages grew strongly over the past two years. But the dangers are large. If the economy continues to weaken, jobs will be at risk.

And last Thursday, Germany’s Federal Labor Agency reported that the country’s labor market cooled in August more than to be expected in a seasonally weak month. The unemployment rate rose slightly from 6.6 percent to 6.7 percent, perhaps a harbinger of things to come.

 

4. The crisis in Ukraine is dramatically hitting exports

Exports to Russia only account for about 3 percent of Germany’s total exports, but the crisis in Ukraine is taking its toll. The sanctions imposed on Russia by the West and the retaliation by Moscow has caused trade with this difficult partner to plummet.

German exports to Russia in the second quarter were a full 18 percent lower than the same period a year earlier. In the first quarter, they were down 13 percent from the previous year.

That drop in exports to Russia worth €1.7 billion caused overall exports growth to weaken to just 1.7 percent in the second quarter from a year ago.

And that is just the calculable effect from direct trade. Since Germany’s biggest trading partner France is sending less to Russia, it also needs fewer goods and services from Germany.

On top of that, the retaliatory sanctions by Russia were only imposed in the third quarter, so things are bound to get worse.

 

German Exports-01

 

In light of the intensification of the political and economic confrontation with Russia, there is bound to be a continued dampening effect on Germany’s export-led economy.

And that will only darken the economic clouds on the horizon.

Russia, of course, is not the only geopolitical problem facing German businesses at the moment. However, trouble spots like Iraq and Syria play only a minor role. Sales to Iraq have also strongly declined, but it only accounts for a fraction of total German exports, making the decline negligible.

 

5. The German government is avoiding needed reforms

If the politicians in Chancellor Angela Merkel’s unwieldy right-left coalition know how to do one thing, it’s formulating harmonious statements. “We will continue to improve the economic climate in order to enable top-quality production and well-paid jobs,” reads the government’s coalition agreement.

According to Ms. Merkel, things should be better for everyone at the end of her third term in 2017. In its first months in office, her government chose to tinker with the crucial reforms of previous years and hand out social goodies. It lowered the retirement age for some workers to 63, agreed to extra retirement payments for mothers and decided to implement a federal minimum wage starting in 2015.

But the coalition of conservative Christian Democrats and center-left Social Democrats has done little to ensure that things continue to go well for people after this legislative period ends. Reforms that would secure productivity over the long-term have been glaringly missing from the government’s agenda. Only changes to the Renewable Energy Act were an attempt to help business in Germany by ensuring reasonable electricity prices.

There is a lack of concrete ideas in the other fields, as the sad state of the country’s digital infrastructure shows. German Economy Minister Sigmar Gabriel and his colleagues are constantly proclaiming its importance.

But how these politicians are concretely supporting its development remains unclear. What is missing, for example, is a strategy to improve the basic economic framework for new technology companies so that as they search for more financing, they don’t end up leaving the country.

It is also unclear if the planned expansion of Germany’s broadband network can be achieved.

And the federal government is also being miserly about expanding investment in public infrastructure as it eyes balancing the budget by 2015.

Accordingly, Ms. Merkel has been steadily rejecting each request for more funding, whether it is for infrastructure, tax cuts or for more research and development. But it’s exactly those sorts of things that would help secure long-term growth.

 

6. Corporate profits are stagnating

The optimistic assumptions at the end of last year: America’s economy would grow at a rapid pace and the euro zone would recover, therefore the net profits of companies in Germany’s DAX stock index were expected to rise by 20 percent in 2014.

But with the year more than half over, German business confidence is dwindling more and more. Thanks to the drop in sales to Russia and the unexpected recent dip in the European market, the outlook is far from rosy.

In addition to Germany, there is also a weakening in core euro zone countries such as Italy and France, where German companies traditionally sell most of their goods.

Germany’s export-oriented companies are also suffering under the comparatively strong value of the euro against the U.S. dollar. Adidas, BASF, BMW, Linde and SAP – almost all large German firms are suffering. It not only raises the prices in the United States and hurts their competitiveness, but it reduces profits and revenues as sales are converted back into euros.

Business slowdown-01

The result: based on quarterly and half-year outlooks, which run from restrained to skeptical, analysts have been lowering their profit forecasts for months. Most recently, predicted profit growth has deflated to only 5 percent.

In just one quarter, the expectations for specialty chemicals company Lanxess, Lufthansa and Deutsche Bank fell by more than 10 percent. Combined net profits for the 30 DAX companies this year they are expected to stay considerably below the record level of €70 billion from the boom year of 2007.

 

7. Business in China is weakening

For years, companies alarmed by weak growth in Europe have placed their bets on China’s booming market. This shift to the Far East has long enabled many German businesses with a strong export focus to achieve impressive results. But now, even the world’s largest consumer market is a source of bad news.

First, Chinese antitrust officials forced German carmakers, businesses long spoiled by success, to lower prices on replacement parts. Raids on several large German-Chinese plants and fines in the hundreds of millions of euros for illegal price fixing were signals to carmakers that the golden days of unlimited growth were ending.

And now, for the first time in more than a decade, the 30 largest publicly traded German companies in China are no longer seeing double-digit sales growth.

A number of companies have even reported declining revenues in China. For instance, Siemens and Daimler did less business in China in 2013 than they did in the previous year.

Chemical producer BASF saw revenue decline by 17.9 percent, to €5.5 billion, in 2013, accounting for only 7.4 percent of global revenue. Deutsche Post, Lanxess, industrial gas supplier Linde and drugmaker E. Merck achieved only minimal sales growth.

On balance, German companies are experiencing sobering declines in business in China. The 30 DAX companies generated revenues of €120.8 billion in the last fiscal year. According to calculations by Handelsblatt in cooperation with EAC, a consulting firm that specializes in emerging economies, this represented a 7 percent increase over 2012.

It was the weakest growth figure in China, by far the most important emerging economy for large German corporations, since the 1990s.

This article was translated by Mary Beth Warner. Ruth Berschens, Ulf Sommer, Daniel Delhaes, Norbert Häring, Hans C. Müller and Axel Schrinner also contributed to this story. To contact the authors: handelsblatt@vhb.de

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