Germany – How Worrisome is the Country’s Recent Slowdown
Germany has over the years come to be seen as Eurozone’s most dependable growth engine and by virtue of its size – it accounts for around a third of the Eurozone economy – it has a significant bearing on the economic prospects of the wider Eurozone region. As such, the recent slowdown in the country’s economy has not only been felt on the domestic front but, more importantly perhaps, has taken a toll on the wider Eurozone economy as well. Against this backdrop, the purpose of this note is to assess the severity of the slowdown in the German and to a lesser extent Eurozone economy, as well as to elaborate on some of the factors that have underpinned this development. We will also endeavour to discuss what policymakers can do to cushion the impact of the recent slowdown. Beyond this, will also highlight some of the other issues to watch as we move the course of this year.
Germany’s growth engine starts to sputter
After enjoying a pretty smooth run for much of the past ten years or so, the German economy hit a stumbling block last year, thanks to the shock sustained by the country’s external sector, particularly on the industrial/manufacturing side, from various sources including the slowdown in the Chinese economy and international trade, the impact of environmental regulation on the country’s automotive sector and, not to mention Brexit, which has negatively impacted German industry through the sentiment channel. Reflecting these developments, the growth of industrial orders has been on a downward trajectory since the latter part of last year (see Chart 1), though there has been a tentative rebound according to the latest data for March. Meanwhile, survey evidence, including the widely-followed Ifo business climate index, has not fared much better either, with the “expectations” component of the index leading the declines. This would appear to suggest that businesses remain cautious about how quickly they expect some of the current uncertainties facing, in particular, the industrial sector of the economy to start to lift.
On the back of these developments, the widest measure of economic activity, gross domestic product (GDP), for Germany declined in Q3 of last year by 0.2% and was essentially flat in the following three months (see Chart 3). While this means that Germany avoided a technical recession during the course of last year – defined as two consecutive quarters of negative growth – the point to note is that the miss was very narrow indeed. For the Eurozone as a whole, while GDP growth also took a hit through the latter part of last year, the scale of the setback was somewhat more tempered, in large part because the likes of Spain and France continued to hold up well, thanks to the strength of domestic demand.
Looking ahead, while more recent data for Germany – not least the Q1 GDP print which rose unexpectedly by 0.4% q/q – suggests that it, and indeed the rest of the Eurozone, seem to have rebounded rather strongly at the start of this year, the underlying situation, particularly in the industrial sector of the German economy, remains uncertain. Indeed, reflecting such uncertainties, the EU Commission as part of its forecast update this month reduced its expectations for German full-year growth to 0.5% y/y for this year and 1.5% y/y for next (see Chart 4), which represents downgrades of 1.3 percentage points and 0.3 percentage points respectively. As part of this exercise, the Commission also slashed the growth forecasts for the Eurozone as a whole, though the scale of downgrades, in this case, were somewhat more modest, thanks to region’s lesser reliance on external trade.
As former tailwinds turn into headwinds
So, what has gone wrong with the German industrial machine? Here, as we alluded to above, the blame lies across the following three areas:
- The slowdown in international trade/China
Germany’s economy – with its relatively high reliance on the manufacturing sector – is Europe’s most formidable exporter both in absolute terms and as a share of GDP (see Chart 5) and ranks number three globally behind China and the US. This openness to trade has meant that the slowdown in international trade, which gained traction through last year, has hit the country particularly badly.
There are several factors at play here. First – and foremost – China’s economic slowdown through 2018 has weakened demand for foreign goods and it’s an important market for Germany (see Table 1). Additionally, in terms of export orientation, Germany happens to specialize in the production of high value-added goods, including capital goods and machinery (see Table 2), which have borne the brunt of the recent slowdown in the Chinese economy, as well as the softening in global trade more generally, thanks in large part because of the heightened trade tensions between the US and China in which other countries have also become embroiled.
Also, of note here is President Trump’s tariffs on steel and aluminium which have adversely affected German and Eurozone exports of these products. Beyond this, the possibility that he might impose tariffs on cars going forward could do a lot more damage to Germany given that the “transportation” segment as whole makes up more than 20% of Germany’s total exports.
- Brexit blues hit home
UK’s Brexit vote has not done Germany any favours. Indeed, the uncertainty associated with Brexit is a recurring concern cited by German firms in their survey responses. This not all that surprising given that the UK is Germany’s fourth largest trade partner to whom it exported almost US$95bn in 2017.
In terms of the likely impact of Brexit on different sectors of the German economy, the automotive sector, in particular, stands out. Indeed, as of 2017, Germany exported a total of some €19bn passenger cars to the UK – making it the country’s second most important market after the US. Given this backdrop, a key risk according to Deloitte is that aside from short-term disruptions of supply chains for some German car manufacturers, a hard Brexit could lead to a drop of around 30% for German car sales in the UK.
- Short-term factors
There have also been some temporary factors that have contributed to Germany’s problems. New emissions testing procedures set back car production last year, while low water levels on the River Rhine – which is a very important transport route for German industry-restricted cargo traffic for a certain period.
Can policymakers come to the rescue
With the German government currently running a budget surplus (1.7% of GDP as 2018), perhaps the most logical way to stimulate the German economy – and cushion the impact of the recent slowdown – is to increase government spending. That said, there is a deep-seated political resistance in Germany to running budget deficits and this has been reinforced by the experience of the European debt crises earlier in the decade.
Meanwhile, on the monetary policy front, the ECB already has interest rates at or close to the lowest level that they can be, which implies that there is little or no room to cut them any further. Indeed, its main rate is zero, while the deposit rate – which is the rate commercial banks get for parking their money overnight with the ECB – is negative.
Also, of note here is the fact that, in terms of unconventional policies, the ECB halted its “quantitative easing” policy of buying financial assets with newly created money at the end of last year. While reviving this remains a possibility, there are certain complications worth bearing in mind. For some assets, the ECB is approaching the maximum amount it wants to hold to avoid distorting the market too much. And politically it would be difficult to sell this policy especially in Germany which where the programme was always viewed with suspicion. “Printing money” as the programme is sometimes called can conjure up fears of high inflation and Germany has had a seriously disruptive period of high inflation during the inter-war period, which continues to linger in the minds of German policymakers.
Taking stock – Is there a silver lining
The unexpected slowdown of the German economy last year took most observers by surprise. While it appears to have bounced back from this “soft patch” at the start of this year, the point to note it will not necessarily be plain sailing from here on in as trade tensions between the world two largest economies – US and China – appear to have taken a turn for the worst recently and – if they’re allowed to continue on this course – they could further undermine global trade growth and, hence, the prospects of open economies such as Germany. That said, the recent slowdown of the German economy should not be taken completely out of context, not least because of the following two factors, which could be viewed as its “silver lining”:
- Although the worst of the industrial-led slowdown of the German economy appears to have passed, the point note is that the downward pressure on the overall economy would have been worse had it not been for the welcome strength of the services sector of the economy. This is set to continue thanks to the resilience of the country’s labour market and the willingness of consumers to go out and spend.
- Germany went into the current slowdown with its fiscal house in order, and should the economic situation worsen much further, it has the option of turning on the fiscal taps, though there is political reluctance to do this at this stage.
Source from: MERatings