DBRS Confirms the Federal Republic of Germany at AAA, Stable trend

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

The rating confirmation reflects DBRS’s assessment that Germany’s competitive economy and its fiscal and macroeconomic policies are likely to support the continuation of the downward trajectory of the public debt ratio. Germany’s broad export base and the positive outlook for domestic demand provide further support to the rating. However, public debt levels remain elevated and Germany’s public finances could come under pressure if the country’s long-term demographic challenges are not addressed or if there was a resurgence of instability in the Euro area, which would result in debt - write downs for the debtor countries or in a call on the guarantees given by the creditor countries under the EFSF and the ESM.

The Stable trend reflects DBRS’s belief that Germany has the political and economic capacity to manage its challenges. The ratings could come under pressure if the debt-to-GDP ratio is put on an upward path over the medium term in the event of marked economic underperformance and sustained fiscal slippage.

Germany’s economy is the largest in Europe and the fourth largest globally. It is well diversified, open to trade and financial flows, and its productivity level is on par with France and just under the US. From Germany’s reunification until the financial crisis, exports flourished due to buoyant external markets, relatively compressed labour costs, and high demand for German products. Net exports contributed to a third of output from 1992 to 2008. While export growth is slowing as a result of weak external demand and unit labour costs are increasing, the export base remains large, at 52.4% of GDP in 2013.

Labour reforms in Germany are credited with introducing greater labour market flexibility and increasing the employment rate from 65.8% in 2005Q4 to 73.4% in 2013Q3. Over the same period, wages rose 17.2%, diminishing some export competitiveness but strengthening domestic demand prospects. Furthermore, the rise in employment and income has bolstered private sector savings, which at 23.1% of GDP in 2013 remain well above the 19.7% average for advanced economies. Both firms and households add to the savings stock and contribute to the country’s large exports of capital. Reflecting high domestic savings is Germany’s current account surplus of 7.5% of GDP and its net foreign asset position of 48.3% of GDP in 2013.

Although Germany’s fiscal and debt position deteriorated during the global financial crisis, its strong fiscal framework should support debt reduction over the medium-term. Gross government debt increased from 65.2% in 2007 to 82.5% in 2010 as a result of government support to the financial sector, government contributions to Euro area financial support programs, and crisis-induced lower growth and higher deficits. In line with the latest IMF projections, Germany’s government debt is expected to decline to under 70% of GDP by 2016 and to under 60% of GDP by 2019 as the fiscal stance remains tight and growth returns. The credibility of Germany’s fiscal consolidation plan is enhanced by the country’s adherence and compliance with the EU fiscal pact. It 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. This pact is stipulated by the constitutionally binding debt break. Germany met its fiscal rule in 2012 and is expected to have registered only a small, 0.5% of GDP, deficit in 2013.

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. Another domestic concern is low domestic investment. The government expects high employment, rising wages, and favourable financing conditions to drive growth over its forecast years. However, the already moderate growth projections might underperform if higher private sector income does not foster consumption or investment and is instead kept as savings, as is the current trend.

A further challenge could emanate from the resurgence of instability in the Euro area which could, in turn, result in the need to write-down some of the lending extended to Greece under the first assistance programme or as part of calls on the guarantees given by Germany under the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM). DBRS assesses that although the German government could still face liabilities arising from the need to boost capital ratios in its banking sector, previous restructuring rounds of the country’s banks and recent improvements in their capital ratios reduce the likelihood that the sector will need further major additional funding injections from the government.

External challenges include low global and EU growth rates, which weigh on the prospects for German exports in 2014. Exports are expected to grow by only 0.8% this year after growing by 3.2% (in line with average annual growth over the 2000-2012 period) in 2013. Looking ahead though, a revival in world growth, and a pick-up in German export growth could provide a boost to investment and underpin growth over the medium-term. However, an escalation of tensions in Central-Eastern Europe (CEE) constitutes a potential downside risk. Germany’s exports to CEE and Russia are significant. The channels of contagion would include the financial sector and the supply of energy. Russia accounts for 36% of Germany’s imports of oil and gas. DBRS believe that in order for growth to be impacted materially, an extreme scenario would need to unfold, with a deep recession in Russia – similar to the Rouble crisis in 1998 – and large spill-overs to CEE countries. DBRS sees such a scenario as currently unlikely.

Notes:
All figures are in euros (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, which can be found on our website under Rating Scales. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

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 Bundesbank, Eurostat, European Central Bank, IMF, OECD, Bloomberg 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 credit 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, while reviews are generally resolved within 90 days. DBRS’s outlooks and ratings are under regular surveillance.

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
Initial Rating Date: 16 June 2011
Rating Committee Chair: Roger Lister
Last Rating Date: 11 October 2013

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