DBRS Confirms Germany at AAA with a Stable Trend

DBRS, Inc. (DBRS) has today confirmed its ratings on 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 has recovered strongly, especially in 2010 and 2011, 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 the fiscal deficit fell to 1% of GDP in 2011, bringing Germany into compliance with the Maastricht ceiling of 3% of GDP.

The ratings are underpinned by moderate growth prospects for a mature economy, a high level of productivity, a high level of 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 the central government structural net borrowing of 0.35% of GDP from 2016 onwards. The ongoing fiscal retrenchment has been made easier as growth has returned, helped by advantageous economy-wide financing conditions. Domestic components of demand have become more important, accounting for two thirds of 2011 GDP growth. As a result of these factors, public debt fell for the first time in 2011 to 81.2% of GDP, and may begin to fall materially over the medium term.

Recent political developments in Greece have called into question the Greek government’s willingness and capacity to comply with the EU-IMF adjustment programme and sustain its membership in the European Monetary Union. However, with the election results of June 17 the risk of an imminent crisis appears to have receded. Still, uncertainty over the future of Greece, which may persist for some time given the scale of the macroeconomic adjustment required, could add to downside risks to the growth outlook in Europe, potentially making public debt reduction more difficult for Germany.

Germany’s economy is the largest in Europe, very open to trade, well diversified, and highly productive with output per hour worked at a similar level to France’s and slightly below that of the United States. Total factor productivity performance has been moderate, growing at an average of 0.8% per year from 1999 to 2007, and accounting for 44% of real value added growth. External demand has contributed about twice as much as internal demand to growth for the period 2000 through 2007 and exports of goods and services reached 50% of GDP in 2011. Price measures point to a strong level of competitiveness, which has likely helped sustain Germany’s very high share of worldwide exports of goods, which has remained in the 8.5% to 10% range.

As a very open economy, Germany was highly exposed to the collapse of world trade in 2009. The resulting contraction in economic activity was deep, with output falling from a peak in the first quarter of 2008 to a trough in the first quarter of 2009 by 6.9%, while in the Euro area GDP contracted by 5.4%. After robust growth of 3.7% in 2010 and 3.0% in 2011, GDP only surpassed its 2008 peak in 2011. Renewed growth in trade, moderate levels of non-financial firm debt at 50% of GDP, and moderate household debt, at 62% of GDP in 2010, 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 12.8% of worldwide net capital exports in 2011.

Despite these strengths, the rapid rise in public debt is a significant challenge. This can be largely attributed to two factors: (1) a higher fiscal deficit and (2) government support for the financial sector. A third smaller factor, namely Euro area financial support, has also added to gross debt. An increase in expenditures combined with a fall in revenues from the downturn in 2009, generated a moderate worsening of the fiscal balance of about 3% of GDP. Nevertheless, a strong pre-crisis fiscal position with a budget that was close to balance helped cushion the impact on public debt dynamics. Moreover, with the strength of the ongoing recovery, the fiscal deficit fell to 1% of GDP in 2011, helping to reduce public debt.

Extensive support to the financial sector of EUR 293 billion, or 11.4% of GDP as of 2011, is mainly responsible for the increase in public debt since 2007. These interventions, which have not added significantly to fiscal deficits, have pushed public debt to 81.2% of GDP in 2011. This is well above the 60% Maastricht ceiling, which has been pierced continuously since 2002. Intra-government lending from the European Financial Stability Facility (EFSF) will add approximately 1.1% of GDP to public debt with current commitments. However, this component of Germany’s debt stock is backed by the loans made by the EFSF. Germany’s EFSF guarantees are capped at EUR 211 billion, or 8.2% of GDP. The permanent European Stability Mechanism (ESM) will add less than 1% of GDP to debt through Germany’s paid-in capital contribution, but could entail significant contingent liabilities.

Under the fiscal retrenchment plan and with strong nominal GDP growth, public debt declined in 2011. This trend will likely continue over the medium term 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 a challenge.

The old age dependency ratio is projected to rise from 31.4% to 35.3% by 2020 and 46.2% by 2030, and is greater than 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 in line with 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 76.3%, and this may help support the financing of the social security system. The trajectory of health care expenditures will partly depend on the evolution of costs as new and better technologies are incorporated.

Good near term growth prospects for a mature economy, a fiscal deficit that has fallen to 1% of GDP, and the possibility of material medium term debt reduction further support the AAA ratings. Nevertheless, if public debt fails to stabilise, which could occur if the fallout from events in Greece or other sovereign stresses in the Euro area were to have adverse systemic consequences, the ratings could come under downward pressure.

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 Federal Statistical Office, Ministry of Finance, Deutsche Bundesbank, Eurostat, IMF, European Commission, OECD and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

This is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer. This rating was assigned without participation by the issuer or any related third party.

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

For additional information on this rating, please refer to the linking document under Related Research.