DBRS Assigns AAA Rating to the Federal Republic of Germany

DBRS Inc. (DBRS) has assigned ratings to the Federal Republic of Germany’s long-term foreign and local currency debt at AAA. The trend on both ratings is Stable. The German economy has shown resilience as it is undergoing a strong recovery after the sharp contraction it experienced when world trade collapsed in 2009. Nevertheless, its banking sector has suffered from large holdings of impaired securitised assets and the ensuing extraordinary government support has substantially increased public debt. However, the deterioration in fiscal balances has been limited and it is likely that the fiscal deficit will comply with the Maastricht ceiling of 3% of GDP this year.

The ratings are underpinned by moderate growth prospects for a mature economy, a high level of productivity, high national savings and strong price competitiveness. Moreover, the credibility of fiscal consolidation has been enhanced with the approval of a constitutional rule in 2009 that places a ceiling on central government structural net borrowing of 0.35% of GDP from 2016 onward. The return of economic growth has facilitated the ongoing fiscal retrenchment. With domestic components of demand showing dynamism, the recovery seems broad-based. As a result, public debt appears to have stabilised and may begin to decline materially over the medium term. Although the governing coalition parties have seen a substantial erosion of political support in local elections, there appears to be widespread consensus on the need to reduce public debt levels.

As a very open economy, Germany was highly exposed to the collapse of world trade. The resulting contraction in economic activity was deep, with output contracting by 7.0% from its peak in the first quarter of 2008 to a trough in the first quarter of 2009. By comparison, in the Euro area, GDP contracted by 5.6% peak to trough. Even after robust growth of 3.6% in 2010, only in the first quarter of 2011 has output recovered its previous peak. Renewed growth in trade, moderate levels of non-financial firm debt at 66.2% of GDP and household debt at 63.9% of GDP in 2009, point to good near-term growth prospects. With a high national savings rate that easily exceeds domestic investment requirements, Germany has posted consistently high current account surpluses and was responsible for 12% of worldwide net capital exports in 2010.

Germany’s economy is the largest in Europe, well diversified, with a large tradable sector and highly productive, with output per hour worked at a similar level to France’s and only slightly below that of the United States. Productivity performance has been good, growing at an average of 0.78% per year from 1999 to 2007, and accounting for 47% of real value-added growth. External demand has contributed about twice as much as internal demand to growth from 2000 to 2007, and exports of goods and services reached 45.1% of GDP in 2010. All price measures point to a strong level of competitiveness, which has likely helped sustain Germany’s very high share of world goods exports at 8.5% to 10%.

Despite these strengths, the rapid rise in public debt is a significant challenge. The increase in expenditures combined with the fall in revenues from the downturn in 2009 generated a comparatively moderate worsening of the fiscal balance of about 3% of GDP. A good starting fiscal position, however, with a budget that was close to balance before the crisis, helped cushion the impact on public debt dynamics. Moreover, with the strength of the ongoing recovery, the government is accelerating compliance with the fiscal deficit ceiling of 3% of GDP this year by targeting a deficit of 2.5% of GDP. Current projections indicate that the fiscal deficit may reach 2% of GDP.

Extensive support to the financial sector of EUR 334 billion, or 13.4% of GDP, as of 2010 is mainly responsible for the increase in public debt. These interventions, which did not add significantly to fiscal deficits, pushed public debt to 83.2% of GDP in 2010. This is well above the 60% Maastricht ceiling, which has been pierced continuously since 2002. Under the fiscal retrenchment plan, it is likely that public debt will start to fall this year and continue its downward path with a progressive reduction of the structural fiscal deficit to 0.35% of GDP by 2016. However, unwinding the extraordinary support measures to the financial sector and addressing the weaknesses of the Landesbank sector, which suffers from a weak business model, remain challenges.

Furthermore, in the event of a sovereign default in Greece, German banks could be affected as their exposure to Greek public debt amounts to US $26.3 billion according to BIS statistics from the third quarter of 2010. If, as an additional consequence, stresses to European financial markets were to return, this could negatively impact German banks as they face debt rollover requirements estimated at 40% in 2011 and 2012. Nevertheless, DBRS believes the sovereign is well placed to provide additional support if necessary.

The old age dependency ratio is projected to rise from 31.4% to 35.3% by 2020 and to 46.2% by 2030, and is greater than the Euro area’s current 28%, reflecting Germany’s older population. Nevertheless, expenditures on pension, health care and long-term care were about 18.7% of GDP in 2007, which is slightly below the Euro area average of 19.1% of GDP. Successive pension reforms have mitigated the medium-term impact of aging on social security pensions. Furthermore, although the population is declining slowly, the employment rate has surged to 74.9% which may help support the financing of the social security system. However, health-care expenditures could rise more significantly depending on the evolution of costs as new and better technologies are incorporated.

As an economy with a large tradable sector, Germany was especially vulnerable to the global downturn. Exports plummeted in 2009, but the deterioration in the labour market was limited as there was intensive use of the short-work government subsidy program, which appears to have limited job losses. Good near-term growth prospects, a fiscal deficit that has remained close to the 3% of GDP ceiling and the possibility of material medium-term debt reduction further support the AAA ratings.

Notes:
All figures are in Euros unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the German Ministry of Finance, Bundesbank, Statistisches Bundesamt, Eurostat, OECD, BIS and IMF. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is the first DBRS rating on the Federal Republic of Germany.

Lead Analyst: Pedro Auger
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 16 June 2011
Most Recent Rating Update: 16 June 2011

This is an unsolicited rating. This rating did not include participation by the rated entity or any related third party, and is based solely on publicly available information.

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