DBRS Confirms Germany at AAA, Stable Trend

DBRS Ratings Limited (DBRS) has today confirmed its long-term foreign and local currency issuer ratings on the Federal Republic of Germany at AAA, and its short-term foreign and local currency issuer ratings at R-1 (high). The trend on all ratings is Stable.

The confirmation reflects DBRS’s assessment that Germany’s competitive economy and its stable fiscal and macroeconomic policies are likely to support a downward trajectory of the public debt ratio. Germany’s broad export base, its current account surplus, and prospects for increased domestic demand provide further support to the rating. However, public debt levels remain elevated due to deficit financing and financial sector support during the financial crisis. Moreover, Germany’s public finances could come under pressure from an escalation of the euro area crisis or from mismanagement of the country’s long-term demographic challenges.

The Stable trend reflects DBRS’s belief that Germany has the political and economic capacity to manage its challenges. The result of the September 2013 election requires the formation of a new government. DBRS expects policy continuity vis-à-vis fiscal prudence from the Angela Merkel led coalition that emerges. The rating could, however come under pressure if debt-to-GDP is put on an upward path over the medium term in the unlikely event of a prolonged period of economic underperformance and sustained fiscal deterioration.

Germany’s economy is the largest in Europe and the third largest globally. It is well diversified, open to trade and financial flows, and its productivity rate is on par with France and just below the U.S. From the reunification of Germany until the financial crisis, exports flourished due to buoyant external markets, compressed labour costs, and high demand for German products. Net exports accounted for third of output growth from 1992 to 2008. While export growth is slowing as a result of weak external demand and increased unit labour costs, the export base remains large, at 51.8% of GDP in 2012.

Labour reforms in Germany are credited with introducing greater labour market flexibility and increasing the employment rate from 66% in 2005 to 73% in 2012. Over the same period, unit labour costs rose 8.6%, reducing export competitiveness but strengthening the prospects for domestic demand. Furthermore, the rise in employment and income has bolstered private sector savings, which at 24.3% of GDP remain well above the 18.4% average for advanced economies. Both firms and households add to the savings stock and push net capital exports worldwide. Reflecting high savings is Germany’s current account surplus of 6.9% of GDP and its net foreign asset position of 40% of GDP in 2012.

The country’s fiscal and debt position deteriorated materially during the global financial crisis primarily as a result government support to the financial sector and government contributions to euro area financial support programs. However, while gross debt increased from 65.1% in 2007 to 82.6% in 2010, the country’s borrowing costs fell from 2.7% of GDP to 2.5% over the same period due to investor confidence in German bunds and flight to safety effects during the crisis. The credibility of fiscal consolidation is enhanced by Germany’s compliance with the EU fiscal pact that aims to keep the structural deficit below 0.5% of GDP through 2016, at which point the structural deficit is not permitted to exceed 0.35% of GDP as stipulated by the constitutionally binding debt break. Germany met its fiscal rule in 2012 and is expected to remain in surplus this year. This strong fiscal stance combined with a return to growth led to an improvement in debt to GDP, which fell to 81.9% in 2012. The IMF projects a debt ratio of 69.8% by 2017.

Despite these strengths, the German economy faces domestic and external challenges. On the domestic front, the debt ratio could reverse its decline as age-related expenditures are expected to put pressure on the public finances over the medium-term. Germany’s old-age dependency ratio of the working-age population is projected to reach 61% by 2040, from 34% today. This is the largest increase among EU countries. However, to offset these demographic costs, the government approved a health insurance reform and made adjustments to the pension formula.

A further source of potential weakness relates to the country’s low share of investment in GDP which at 17.8% on average over the 2002-2012 period was below the 22.3% average for the advanced economies. The government expects domestic factors, such as tight employment, rising wages, and favourable financing conditions to drive growth over its forecast years. However, the economy may underperform if higher private sector income does not stimulate consumption or investment and is instead kept as savings as uncertainty with respect to the economic outlook abroad weighs on investor and consumer sentiment.

External challenges include low global and EU growth rates, which have weighed on German exports. Exports are expected to grow by 2.2% this year, after increasing 18.1% in 2010, 11.6% in 2011, and 4.0% last year. In addition, German banks are active in international and loan markets and remain exposed to distressed euro area periphery economies. The cost to the German government of the financial crisis totalled 11.1% of GDP as of 2012. Furthermore, Germany is the largest contributor to EU stability mechanisms with guarantees capped at €190 billion in capital to the ESM. Any escalation of the euro area crisis that requires recapitalization to domestic banks or distressed European countries could generate significant liabilities for the government.

Notes:
All figures are in euro (EUR) unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships. These can be found on www.dbrs.com at: http://www.dbrs.com/about/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.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Information regarding DBRS ratings, including definitions, policies and methodologies are available on www.dbrs.com.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

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

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Carla Clifton
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 16 June 2011
Most Recent Rating Update: 16 November 2012

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