S&P: Germany ‘AAA/A-1+’ Ratings Affirmed; Outlook Stable

OVERVIEW

  • In our view, Germany has a highly diversified and competitive economy with a demonstrated ability to absorb large economic and financial shocks.
  • Germany also benefits from low interest rates, which help lower sovereign borrowing costs in the medium term.
  • We are affirming our unsolicited ‘AAA’ long-term and ‘A-1+’ short-term sovereign credit ratings on Germany.
  • The stable outlook reflects our view that Germany’s public finances and strong external balance sheet will continue to withstand potential financial and economic shocks.

RATING ACTION

On Jan. 9, 2015, Standard & Poor’s Ratings Services affirmed its unsolicited ‘AAA/A-1+’ long- and short-term foreign and local currency sovereign credit ratings on the Federal Republic of Germany. The outlook is stable.

RATIONALE

The affirmation reflects our view of Germany’s modern, highly diversified, and competitive economy, and the government’s track record of prudent fiscal policies and expenditure discipline. Furthermore, we believe that the German economy has demonstrated its ability to absorb large economic and financial shocks.

We estimate that the German economy expanded by 1.4% in 2014, up from 0.1% real GDP growth in 2013, and we forecast 1.1% growth for 2015. In per capita terms, this translates into real GDP growth averaging 1% over 2014 and 2015.

Germany’s economic model remains largely unchanged, driven by high net exports as well as relative competitiveness from years of corporate restructuring, wage restraints, and high savings rates. These factors have also enabled it to generate sizable trade and current account surpluses, which have led to a solid net external creditor position (including non-debt assets and liabilities). We do not consider Germany’s private- or public-sector balance sheets to be under any material strain. Unlike most other highly rated peers, Germany has avoided the need for significant private-sector deleveraging and fiscal consolidation as it did not rely on higher borrowing during the boom years. At close to 200% of GDP in 2013, the total leverage ratio of resident sectors (households, nonfinancial corporations, and government) was virtually unchanged from 1999, the year the euro was introduced.

Nevertheless, we expect consumption to expand only modestly despite the introduction of an economy-wide minimum wage in January 2015. Third-quarter 2014 data confirms that wage growth is indeed picking up (at an annualized rate of 1.8%), although increased immigration should contain any labor shortages. In this regard, it is notable that Germany has become the OECD’s second-largest recipient of net immigration with 465,000 immigrants (1.1% of the labor force) in 2013, double the 2007 figure.

Current economic growth is also fairly broad and, despite rapid price appreciation in specific German property markets, we do not consider the national housing market to pose systemic risks to the economy. Mortgage loan
growth remains low: it peaked at 2.5% year-on-year in early 2014. Furthermore, housing prices remain more than 10% below their long-term averages in terms of price-to-rent as well as price-to-income ratios.

The government has said that it will maintain tight fiscal policies to comply with its constitutional fiscal rule. In addition, some of Germany’s major trading partners are still reducing debt, which we believe will weaken external demand for German goods and services. As a result, we forecast that the current account surplus will shrink marginally to 6.4% of GDP by 2017, from 6.9% in 2013.

Germany is primed for a period of balanced general government budgets. We believe balances will stay closely aligned with the new constitutional target of limiting structural federal government net lending to below 0.35% of GDP. In detail, we forecast deficits to average 0.13% of GDP in 2014-2017, a performance facilitated by a reasonable growth environment.

Moreover, low deficits are being supported by a very favorable interest rate environment. The German government was able to issue 10-year federal bonds at 0.7% in November 2014, less than half the cost for U.S. or U.K. peers. This has also reduced our measure of the German government’s structural interest burden–namely, general government interest payments as a share of general government revenues. In 2013, this measure dipped below 5.0% for the first time, reaching an all-time low of 4.5%. We now forecast it to remain close to 4.0% at least until 2017, even if effective interest rates were to reverse and rise by an average of 10 basis points per year.

As a result, we expect Germany’s net general government burden to gradually decline to closer to 65% of GDP in 2017, from 73% in 2013. Under our methodology, this figure does not include liabilities arising from the various multilateral financial support mechanisms (European Financial Stability Facility [EFSF] and European Stability Mechanism [ESM]) in the eurozone, which we consider to be contingent liabilities.

A renewed eurozone crisis could hit Germany’s economy through a number of channels. We currently do not consider this a likely scenario, however. Instead, we expect an orderly resolution of the simmering debt crisis in parts of the eurozone. Germany’s contingent liabilities from EFSF and ESM amount to 8% of GDP in a worst-case scenario. Direct exports to EU peripherals (Italy, Spain, Portugal, Cyprus, and Greece) were less than 4% of German GDP in 2013. However, German commercial bank claims at the end of June 2014 on the aforementioned countries still totaled $295 billion, according to the Bank for International Settlements. At 7.7% of GDP, this is less than half the 2008 figure, but has stayed roughly the same since mid-2012. In contrast, Germany’s Target 2 surplus has declined by about one-third since then, though it remains elevated at €480 billion, a level first reached in late 2011.

From a monetary perspective, we consider Germany’s eurozone membership to reduce its monetary flexibility, but we note that Germany has benefited from the euro. Eurozone membership has also largely shielded the German tradables sector from currency appreciation pressure, supporting an increase in the export share to 52% of GDP in 2013, from an average of 26% of GDP in the five years before the introduction of the common currency.

OUTLOOK

The stable outlook reflects our expectation that Germany’s public finances will continue to withstand potential financial and economic shocks and that consensus in favor of prudent economic policies will remain. We expect these factors to contain the net general government debt ratio and sustain the economy’s net external creditor position.

We could lower the ratings on Germany if we perceived a reduction in the country’s monetary flexibility, particularly in conjunction with an unexpected weakening of public finances. This could occur, for example, if consistently larger-than-anticipated deficits significantly exceed the constitutional limit. An unexpected surge in contingent liabilities, particularly from the banking sector, or other contagion effects from a revived eurozone crisis, could also create downward pressure on the ratings if sovereign support were needed. We currently do not expect these scenarios to materialize over the outlook horizon (up to 24 months).

source: standard & poor’s

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