DBRS Confirms Federal Republic of Germany at AAA, Stable Trend

DBRS Ratings Limited (DBRS) confirmed the Federal Republic of Germany’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS 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’s view that Germany’s credit fundamentals remain solid, despite recent weak economic performance. Economic growth in 2018 turned out lower than expected, below the euro area, and the forecast for 2019 has been revised downward to less than 1%. Nevertheless, growth is expected to pick up in the second half of 2019 and strengthen in 2020. Moreover, DBRS expects the German government to continue posting a healthy budget position and the government debt ratio is set to decline further, despite stimulative fiscal measures. In 2019, the government debt-to-GDP ratio is projected to fall below 60% for the first time since 2002.

Germany’s AAA rating is supported by its large, competitive and diverse economy, its sound public finances and strong and credible fiscal framework, and a robust external position, which provides ample buffers to absorb shocks. The country also faces some 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 system or higher fiscal burden sharing within the currency union, could weigh on public finances in the future.

RATING DRIVERS

Germany is strongly placed within the AAA category. DBRS could change the trend to Negative 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 substantial materialisation of contingent liabilities could put negative pressure on the ratings.

RATING RATIONALE

Growth is Expected to Strengthen After An Slowdown But Demographic Challenges Lie Ahead

Real GDP growth in 2018 came in at a lower-than-expected 1.4%, down from 2.2% in 2017. External and temporary factors, including the transition to the new car emissions testing standards, affected economic activity in the second half of 2018. Nevertheless, domestic demand has remained healthy. Construction activity is robust. Public investment grew by 7.6% in 2018 and is expected to increase further. The unemployment rate remains very low, at 3.2% in April 2019, while labour shortages are pushing wages up. In 2019, domestic demand is set to remain the main growth driver, with stimulative fiscal measures providing some impulse to the economy. The external environment is expected to remain somewhat weak. The European Commission is now forecasting real GDP growth of 0.5% in 2019, in line with Germany’s Ministry of Economy, followed by 1.5% in 2020.

Downside risks to the outlook are mainly external. Germany’s export-oriented industrial sector, well integrated into global value chains, could disproportionately suffer from weaker external conditions or protectionist measures. In particular, potential US tariffs on imported cars and parts from the EU could have a substantial impact on German exports, as the US is Germany’s main importer, especially for motor vehicles. A no-deal Brexit, a slowdown in the Chinese economy or an increase in geopolitical tensions are additional downside risks. Over the long-term, a key challenge for the German economy is to manage the impact of a shrinking population on potential growth.

Germany’s large, competitive and diverse economy enjoys a good degree of resilience. The healthy position of households, firms and the public sector enable them to absorb shocks and support Germany’s long-term growth prospects. The government estimates the growth of potential output currently at 1.6%. One of the objectives of the government is to enhance the growth drivers of the German economy. To achieve its objective, the government is planning to increase investment in infrastructure, education and research over the next four years.

Public Finances Remain Sound And The Public Debt Ratio is Trending Down

Germany has accumulated budgetary surpluses at the various levels of government (federation, states, local authorities, and social security funds) since 2014. In 2018, the general government recorded a higher-than-expected fiscal surplus of 1.7% of GDP. The structural surplus was 1.4%. The debt brake rule and the government’s intention to avoid issuing new debt, act as anchors for Germany’s strong fiscal performance.

For the next four years, the government is planning to use the fiscal space to continue increasing public investment and provide tax relief. In its coalition agreement, the government set a cumulative fiscal stimulus of 4.0% of GDP between 2019 and 2022. Expenditure measures amount for most of the stimulus (2.6% of GDP). In 2019, discretionary measures amount to 0.6% of GDP. While the fiscal surplus is set to decrease, DBRS expects Germany will maintain a healthy budget position. Over the longer term, the main challenge to fiscal sustainability stems from the demographic dynamics because of the country’s declining working-age population. In response, the government has set up a ‘commission on intergenerational fairness’ to review the pension system, with the recommendations expected by March 2020.

The general government debt-to-GDP ratio stood at 60.9% of GDP in 2018 and remains on a downward trend. After peaking at 81.8% of GDP in 2010, the debt ratio has steadily fallen on the back of sizeable primary surpluses, lower interest costs, economic growth and ongoing winding down of the resolution entities. According to the government’s Stability Programme, the public debt ratio will fall to 58.8% in 2019 and to 53.0% by 2022. Moreover, Germany enjoys a safe-haven status. For the past several years, the government has benefited from very favourable financing conditions.

The External Sector is Expected to Remain One Of The Strongest in Europe

The German external position remains very strong. A competitive industrial sector is to a large extent accountable for Germany’s sizeable goods trade surplus. Although some cyclical factors have contributed in recent years, structural factors – including German firms’ savings and an ageing population incentivising households’ savings – have driven large surpluses in the current account. Large and persistent current account surpluses, averaging 6.1% of GDP between 2002 and 2018, have enabled Germany to build up a strong net external asset position. Germany’s net international investment position stood at 60.5% of GDP at the end of 2018.

Over the coming years, the current account surplus is set to gradually decline. The government is forecasting the surplus to decrease from 7.4% of GDP in 2018 to 6.5% in 2022. Strengthening domestic demand, bolstered by fiscal stimulus and rising disposable incomes, is expected to spur demand for imports. In contrast, export growth could prove weaker than previously expected in the wake of intensifying protectionist measures, a worse-than-expected Chinese slowdown, and higher cost pressures in Germany.

Financial Stability Risks Are Moderate

DBRS views risks to financial stability, mainly associated with the continued buoyance of the property market and potential underestimation of credit risks, as moderate. Nationwide, house price increases seem to largely reflect rising household income, immigration, supply bottlenecks and supportive credit conditions. Price increases have been stronger in certain metropolitan areas. Bundesbank’s estimates suggest that house prices in German cities could be overvalued by between 15% and 30%. However, there seems to be no evidence of a debt-driven property boom. Household debt remains low, mortgage debt servicing is not vulnerable to abrupt interest rate rises, as most mortgages are fixed rate, and homeownership is relatively limited in Germany, mitigating macroeconomic and financial stability risks.

Credit standards have eased only marginally, but lending growth seems to be picking up. In May 2019, the German Financial Stability Committee made a recommendation to the Financial Supervisory Authority to activate the domestic countercyclical capital buffer, lifting it to 0.25% from the third quarter of 2019, to enhance the resilience of the financial system. In recent years, German authorities have also broadened their macroprudential toolkit to include borrower-based measures (limits on the loan-to-value ratio and amortisation requirements).

German banks’ capital positions look resilient but profitability is weak. Stress test results in 2018 for the eight large banks confirm their resilience. The favourable macroeconomic environment has translated into improved asset quality and low provisioning needs. Non-performing loans were just 1.3% of total loans at end-2018. Furthermore, although politically challenging, ongoing restructuring efforts in the Landesbanken (state-owned banks) sector could strengthen efficiency and reduce risks in the banking system. On the other hand, net interest margin compression has put pressure on profitability, amid a low interest rate environment and high cost-to-income ratios. The overall German financial sector could benefit from a gradual increase in interest rates, but both the banking and insurance sectors are vulnerable to a sharp rise in interest rates given their maturity mismatch.

Solid Institutions And Stable Political Environment Reassure Policy Continuity

Germany benefits from solid political institutions, minimising the risks associated with the more fragmented political landscape following the federal elections in 2017. Exploiting some discontent associated to the large inflow of asylum seekers in 2015/2016, the anti-immigration Alternative for Germany gained seats in the Bundestag and regional parliaments in Germany. Nevertheless, parties in the centre of the political spectrum, including the Christian Democratic Union (CDU)/Christian Social Union in Bavaria (CSU) and the Social Democratic Party of Germany (SPD), the Greens, and the Liberals, continue to account for most of the seats. After months of negotiation talks, the CDU/CSU and SPD renewed the grand coalition government in March 2018, with Chancellor Angela Merkel remaining in office, since 2005.

Changes in parties leadership have added some degree of uncertainty to German politics. Following Chancellor Angela Merkel’s decision to step down as party leader of the CDU, Ms Annegret Kramp-Karrenbauer was elected as the new leader in December 2018. At the European elections and the regional vote in Bremen in May 2019, the SPD suffered significant losses, prompting concerns about the durability of the grand coalition. Despite some political uncertainty in the medium term, DBRS expects broad economic policy continuity and continued support for European integration.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AAA – AA (high) range. The main points discussed during the Rating Committee include Germany’s economic performance and outlook, fiscal policy, banking sector, and political environment.

KEY INDICATORS

Fiscal Balance (% GDP): 1.7 (2018); 1.0 (2019F); 0.8 (2020F)
Gross Debt (% GDP): 60.9 (2018); 58.4 (2019F); 55.6 (2020F)
Nominal GDP (EUR billions): 3,386 (2018); 3,476 (2019F); 3,603 (2020F)
GDP per Capita (EUR): 40,852 (2018); 41,858 (2019F); 43,342 (2020F)
Real GDP growth (%): 1.4 (2018); 0.5 (2019F); 1.5 (2020F)
Consumer Price Inflation (%): 1.9 (2018); 1.5 (2019F); 1.5 (2020F)
Domestic Credit (% GDP): 142.5 (2017); 144.0 (2018)
Current Account (% GDP): 7.4 (2018); 8.1 (2019F); 7.9 (2020F)
International Investment Position (% GDP): 54.4 (2017); 60.6 (2018)
Gross External Debt (% GDP): 145.0 (2017); 143.2 (2018)
Governance Indicator (percentile rank): 94.2 (2016); 94.2 (2017)
Human Development Index: 0.93 (2016); 0.94 (2017)

EURO AREA RISK CATEGORY: LOW

Notes:

All figures are in euro (EUR) unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Fiscal balance (Bbk/EC forecast), Gross debt (Bbk/EC forecast), Nominal GDP (Federal Statistics Office/EC forecast), GDP per Capita (Federal Statistics Office/EC), Real GDP Growth (Federal Statistics Office/EC forecast), Inflation (EC), Domestic Credit (Bbk), Current Account (Bbk/EC forecast), International Investment Position (Bbk), Gross External Debt (Bbk). Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include Germany’s Federal Ministry of Finance, German Finance Agency (Deutsche Finanzagentur), Deutsche Bundesbank (Bbk), Federal Statistical Office, European Banking Association, European Commission (EC), Statistical Office of the European Communities, European Central Bank, IMF, World Bank, UNDP, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

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

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

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.

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 further information on DBRS 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.

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

Lead Analyst: Adriana Alvarado, Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: June 16, 2011
Last Rating Date: December 7, 2018

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