DBRS Morningstar Confirms Federal Republic of Germany at AAA, Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Federal Republic of Germany’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed the Federal Republic of Germany’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS

The Stable trend reflects DBRS Morningstar’s view that Germany’s credit fundamentals remain solid, despite the sharp macroeconomic shock from the global Coronavirus Disease (COVID-19) pandemic. Germany’s large economic contraction was less severe than initial expectations in large part due to the sizeable policy response. The government used its ample fiscal space and the flexibility provided within its fiscal framework to support the healthcare system and the economy. As a result, Germany’s public finances deteriorated last year. DBRS Morningstar nevertheless expects a gradual rebalancing of public sector accounts as the health and economic shocks recede.

Germany’s AAA ratings are supported by its large, competitive and diverse economy, its sound public finances and strong and credible fiscal framework, and a robust external position that provides ample buffers to absorb shocks. However, the country faces long-term challenges stemming from its underlying demographic trends and contingent liabilities. The projected decline in the working-age population poses challenges to Germany’s growth potential and the long-term sustainability of its public finances. Contingent liabilities, emanating from the financial sector, large state guarantees, and fiscal burden sharing within the currency union, could eventually weigh on public finances.

RATING DRIVERS

Germany is strongly placed within the AAA category. DBRS Morningstar could downgrade the ratings if the country’s growth and fiscal prospects deteriorate severely enough to place the public debt-to-GDP ratio on a persistent upward trajectory. Moreover, a materialisation of substantial contingent liabilities could put negative pressure on the ratings.

RATING RATIONALE

After Over A Year of Rolling COVID-Related Restrictions, There Is Reason For Optimism

Germany’s early success in containing the spread of the virus was complicated late last year. The unified policy messaging began to fracture and by October 2020 COVID-related cases and deaths began to rise again exponentially. In late November 2020, stricter measures were imposed at the federal level that remained broadly in place through the first months of 2021. As of late May 2021, mortality rates in Germany were comparable to a year earlier and the health situation appears to be rapidly improving. The vaccine rollout in Germany and across Europe provide some promise for a return to more freedom of mobility and activity in the coming months.

After A Sharp Contraction, A Robust Recovery Of The German Economy Is Expected This Year And Next

Disruptions in external trade and global supply chains, together with several rounds of containment measures, forced the German economy to contract by 4.9% in 2020. Different economic sectors were affected to varying degrees during the course of last year. The manufacturing sector declined sharply due to a large downturn last spring at the initial stage of the pandemic, while the performance of the service sectors was mixed over the year. The contraction of economic activity was large in sectors dependent on face-to-face interactions such as hospitality, transport, and retail. In contrast, services provided at a distance such as online retail trade grew significantly. The pandemic also had little impact on the construction industry.

The recovery this year and next is expected to be significant, although the outlook depends on the evolution of the pandemic. As of end of May 2021, Germany administered just under 60 million vaccinations, and roughly 17% of the population was fully vaccinated. Assuming a persistent pace of inoculation in Germany and across Europe, and greater control over the health risks, an increase in external demand would support the recovery of export markets and global supply chains. Furthermore, the government’s support programs – including efforts to preserve corporate solvency with tax cuts, loans, and guarantees, and efforts to limit job losses via the short-term work scheme (Kurzarbeit) – have created the conditions for a strong recovery in domestic demand as mobility restrictions are eased. The European Commission (EC) expects GDP to increase by 3.4% in 2021 and by 4.1% in 2022.

Germany’s Extraordinary Fiscal Expansion Last Year Deteriorated Its Public Finances

The Federal government adopted two supplementary budgets last year to finance support measures to contain the severe downturn caused by the coronavirus pandemic. Through an exception clause, the German Bundestag allowed the government to exceed the structural deficit limit of 0.35% of GDP (the statutory debt brake rule), with the government also suspending its commitment to a balanced federal budget, known as the “black zero” approach. The government originally provisioned over EUR 200 billion in support and stabilization measures to assist households and businesses and to strengthen the healthcare system. The stimulus also contained measures to boost medium-term investment to address structural challenges.

Yet, net borrowing for 2020 turned out smaller than initially expected, as the pay-out of some support measures only materialized in 2021. The deficit, which deteriorated to 4.2% of GDP in 2020 following several years of general government surpluses, is thus expected to widen further in 2021. Including increased spending on COVID-19 testing, vaccinations, and additional measures financed by the EU Recovery and Resilience Facility (RRF), the EC projects a 7.5% deficit in 2021. The deficit is expected to narrow to 2.5% in 2022 assuming the economic recovery persists and temporary support measures are wound down.

As a result of the new borrowing, general government debt increased by 10 percentage points of GDP in 2020. After falling below 60% in 2019, the debt ratio reached 69.8% in 2020. The government expects the ratio to peak at 74.5% this year and decline only gradually over the forecast period. Despite the sharp increase in debt, the government benefits from very favourable financing conditions, with debt servicing expenditures expected to equal roughly half a percent of GDP each year over the forecast period. Germany continues to enjoy a safe-haven status. This supports DBRS Morningstar’s positive qualitative assessment of the “Debt and Liquidity” building block.

Irrespective Of The Government That Emerges From The 2021 Federal Election, Expect Broad Policy Continuity

The Federal election in Autumn 2021 will likely result in a change in the governing coalition and will usher in a new German Chancellor. Angela Merkel will step aside after 16 years of leadership. The Christian Democratic Union (CDU) and the resurgent Greens party remain close in the polls, each garnering around 20-25% of support as of late May 2021. A governing coalition that includes the CDU/CSU and the Greens appears to be the most likely outcome, but alternative are also possible. The high polling of the Greens points to the growing importance among the German populace of the energy transition. Germany recently raised its climate ambition and now targets net zero greenhouse gas emissions by 2045, five years earlier that the previous plan. Despite some political uncertainty around the makeup of the next government, DBRS Morningstar expects broad economic policy continuity. Germany is a strong performer on the World Bank’s Governance Indicators.

Price Pressure Will Likely Increase Temporarily This Year; The Rise In Financial Stability Risks Appear Manageable

The rise in inflation this year will be material, but likely temporary. The consumer price index increased in May by 2.4% from a year earlier, motivated by base effects from rising energy prices, the reversal of VAT price cuts from last year, and a new carbon tax that began in January 2021. Net of food and energy prices, core inflation increased by 1.7% in May. The Bundesbank in its monthly report in May 2021 said it expects inflation could reach 4% by the end of the year. That said, sluggish real wage growth will likely mute price pressures over the forecast period. The EC expects consumer prices to expand by 1.4% in 2022.

German banks entered the crisis with resilient capital positions and strong liquidity. Moreover, the majority of the Landesbanken have now been restructured, reducing risks in the banking system. However, profitability has been weak and the operating environment has deteriorated with the current crisis. Net interest margin compression has put pressure on profitability amid low interest rates, constraining German bank’s ability to absorb significant increases in credit costs.

The main emergent risk to financial stability stems from a potential sharp rise in insolvencies of corporates affected by the crisis. A sharp rise in insolvencies could lead to high loan defaults and losses for banks. While asset quality is still good, the full impact from the pandemic has not yet materialised, and credit costs are likely to increase. Rising property prices is an additional legacy risk that existed prior to the pandemic. The German residential property prices index increased by roughly 6.5% per year from 2016 to 2020.

DBRS Morningstar is of the view that these challenges are manageable. While the crisis has been severe, the corporate sector’s largely sound balance sheets and the government’s liquidity support measures should limit a sharp rise in corporate failures. Likewise, there is no evidence of a debt-driven property boom. The rise in property prices reflects rising household income, immigration, supply bottlenecks, and supportive credit conditions. Further mitigating macroeconomic and financial stability risks from rising property prices, household debt remains low, most mortgages are fixed-rate, and homeownership in Germany is relatively low.

The German External Sector Remains One of The Strongest in Europe

Despite weak external demand in 2020, Germany’s external position remains very strong. Germany’s competitive industrial sector in part accounts for Germany’s sizeable goods trade surplus. The coronavirus shock did not materially affect Germany’s trade balance, as the 9.4% decline in the exports of goods and services was broadly offset by the comparable 8.5% decline in the imports of goods and services. As such, the country’s current account surplus remained above 7% of GDP in 2020, where it is expected to remain this year. Germany’s strong external account savings position can also be attributed to high household and corporate savings rates, making Germany a strong net creditor. Its net international investment position stood at 76.2% of GDP in 2020, from 46.6% in 2015. This formidable external savings position supports DBRS Morningstar’s positive qualitative assessment of the “Balance of Payments” building block.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/379703.

EURO AREA RISK CATEGORY: LOW

DBRS Morningstar notes that this press release was amended on 9 June 2021 to incorporate the telephone number of the issuing office.

Notes:

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883

All figures are in EUR unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments (July 27, 2020).

Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).

The sources of information used for this rating include Germany’s Federal Ministry of Finance (2021 Stability Program), Federal Ministry for Economic Affairs and Energy (Federal Government’s Spring Projection 2021), the Federal Government (Measures by the Federal Government to contain the spread of the COVID-19 pandemic and address its impacts), German Finance Agency (Deutsche Finanzagentur), Deutsche Bundesbank (Monthly Report May 2021), Federal Statistical Office, Federal Financial Supervisory Authority (BaFin), ifo Institute, European Commission (2021 Spring Forecasts), Statistical Office of the European Communities, European Central Bank (ECB), IMF (World Economic Outlook April 2021), IMF (International Financial Statistics), Germany Climate Action Plan, Climate Action Tracker, Social Progress Index, World Economic Forum Global Competitiveness Index, World Bank, UNDP, BIS, Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

DBRS Morningstar 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.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.
The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/379702.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.
Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Financial Institutions and Sovereign Ratings
Initial Rating Date: June 16, 2011
Last Rating Date: December 4, 2020

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