DBRS Confirms Republic of Germany’s Rating at AAA, Stable Trend

DBRS Ratings Limited (DBRS) has today confirmed the Federal Republic of Germany’s long-term foreign and local currency issuer ratings at AAA and the short-term foreign and local currency issuer ratings at R-1 (high). All ratings have a Stable trend.

The confirmation of the Stable trend reflects DBRS’s view that the challenges faced by Germany are broadly balanced. The ratings could come under downward pressure in the event of a marked deterioration in growth prospects that places the public debt to GDP ratio on a persistent upward trajectory. A re-awakening of the sovereign debt crisis, resulting in a large impact on Germany’s stock of public sector debt through the country’s participation in the various euro area rescue mechanisms, could also put downward pressure on the ratings.

Germany’s sound track record of fiscal consolidation, its large and competitive economy and a very favourable net foreign asset position are key factors supporting the ratings. The German government has made substantial progress on fiscal consolidation in recent years and it has credible plans to continue to reduce its stock of debt. Increased growth momentum and improvements in the country’s financial sector also support the rating, although vulnerabilities remain, associated with weak profits and some riskier portfolios in parts of the financial system.

The German economy does however, face some challenges related principally to the costs associated with its ageing population and the low levels of investment which are likely to depress potential output. Germany’s wealthy and export-oriented economy has weathered the financial and sovereign debt crises relatively well. A strong and diversified export market, healthy private sector balance sheets, as reflected in a modestly indebted non-financial sector, a high level of savings, and the successful restructuring of the banking sector; all played a role in supporting growth during the crisis.

Looking ahead, GDP is expected to expand by 1.7% in 2014 and 1.6% in 2015, supported by an improvement in domestic demand. DBRS expects that households' strong balance sheets and continued growth in real wages and in disposable income will support private consumption. The robust performance of the labour market, with unemployment set to decline further to 5.2% in 2014 and 2015, from 5.3% in 2012, should further support domestic demand. Germany is also anticipated to continue to benefit from a strong external balance sheet, as reflected in a net foreign asset position of 48.4% of GDP in 2013.

Germany’s progress on fiscal consolidation and its strong fiscal framework bode well for its ability to bring public debt down to the 60% Maastricht threshold over the medium-term. Positive growth, healthy primary surpluses and the reduction in interest costs have been key factors supporting debt reduction to date. Government debt to GDP ratio eased to 79.6% in 2013 from 81.9% in 2012. Over the medium-term, growth of 1.5% per annum and primary surpluses of around 2.0% of GDP are expected to underpin further reductions in the debt to GDP ratio, further improving the shock-absorbing capacity of the sovereign.

Risks stemming from the banking sector are also gradually diminishing. The restructuring of the financial sector reduced financial vulnerabilities, whilst preserving the ability of the banks to provide credit to the economy. Deleveraging reduced the size of bank balance sheets to 270% of GDP in 2013, from 311.5% in 2008. The capital adequacy ratio for the sector improved from 9.6% in 2008 to 15.6% in 2013. The supervisory and regulatory framework has also been strengthened, notably with the introduction of the Act on Monitoring Financial Stability and the coming into operation of the Financial Stability Committee in 2013. Moreover, the implementation of the European Capital Requirements Directive and Regulation (ECRDR) which calls for the adoption of countercyclical capital buffers and systemic risk buffers and an increase in risk weights for certain types of assets, also points to further improvements in financial stability. Notwithstanding such progress, Germany’s financial system still faces some headwinds, such as the low interest rate environment and the exposure by some institutions to riskier foreign commercial real estate assets and the shipping industry.

Contingent liabilities have declined substantially in recent years as many of the guarantees provided to the banking sector have now expired. Total contingent guarantees, which include those pertaining to the euro area rescue mechanisms, fell from 23.5% of GDP in 2011 to 19.4% of GDP in 2012. DBRs believes however that the government remains well positioned both institutionally and in terms of its fiscal position, to absorb the potential crystallisation of liabilities currently outside the government balance sheet.

Demographic trends continue however to pose a significant challenge to Germany’s growth potential, especially in face of growing support for restrictions on immigration. DBRS takes comfort from the government’s adoption of a comprehensive set of measures aimed at boosting the participation and employment rates of women, older workers and the long-term unemployed. These should help to mitigate the decline in the participation rate and reduce the pressure on trend growth going forward.

Another challenge facing Germany’s medium-term outlook relates to the weak prospects for investment spending which could continue to weigh on the contribution of domestic demand to growth and reduce the contribution of total factor productivity to growth potential. Germany has the second lowest investment to GDP ratio in the OECD and net public investment has been negative since 2003. Weak investment has helped perpetuate the poor state of German infrastructure, especially in areas like roads and transportation. Moreover, sub-optimal levels of investment in renewable sources of energy have added to the vulnerabilities associated with geopolitical developments in Russia and the Ukraine, given that Russia accounts for 36% of Germany’s imports of oil and gas.

Notes:
All figures are in Euro 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.

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 Deutsch Bundesbank, the Ministry of Finance, the German debt Agency (i.e. the Deutsche Finanzagentur), the Federal Statistical Office, the IMF, the OECD, the European Commission, 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, Assistant Vice President.
Initial Rating Date: 11 November 2011
Rating Committee Chair: Alan G. Reid
Last Rating Date: 11 April 2014

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