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ERA affirms AAA rating to Germany, outlook Stable
Piatok, 12 Apríl 2019

Affirmation of the unsolicited credit rating AAA assigned to Germany stems from a strong decline in public debt supported by a tight fiscal rule, relatively low private debt, high current account surpluses, and very strong governance indicators.

Rating components

Macroeconomic factors

Economic factors

High

Debt and current account sustainability factors

Very high

Public finance factors

High

Private finance factors

High

Foreign exchange stability factors

Very high

Liquidity factors

Very high

Final assessment

Very high

Forward-looking factors

Political and economic stability

Very high

Efficiency and reforms potential

Very high

Final assessment

Very high

Overall score

Very high

Final rating

AAA

Macroeconomic factors of rating assessment

The German government's finances have been very tight in the recent years, which led to a strong decrease in debt-to-GDP ratio. Its low risk profile is enhanced by robust current-account surpluses and relatively low private sector debt.

Economic slowdown driven by exports and manufacturing:

After four years of solid growth, largely due to the recovery of the global economy, the growth of the German economy slowed down to 1.4% in 2018. This was primarily caused by a slowdown in export growth (driven down by lower exports to the UK and several emerging economies). Another important factor was the launch of new emissions testing in the automotive industry, slowing car production due to lack of test facilities. The year-on-year growth in manufacturing slowed down from 3.4% to 1.1% in 2018.

ERA expects weak development in industrial production in 2019, as indicated by soft indicators from the business sector as well as industrial orders. On the other hand, domestic consumption should support the economy as consumer confidence remains at very high levels, despite the slowdown of the economy (due mainly to strong labour market developments). The unemployment rate remains at the lowest levels since reunification and second lowest in the EU (3.2% in Q4 2018) with firms continuing to report a shortage of skilled labour (22% in industry and services, according to the January EC survey), which is a positive environment for wage growth; negotiated wages grew by 2.8% in 2018 (the fastest since 2014).

In 2019, ERA expects the economy to grow by around 1%, with the potential for acceleration in 2020. However, the risks are rather tilted to the downside and are mainly related to tensions in international trade. The threat to the highly opened German economy (unusual for its large size) is not just the tensions between the US and China, but also the effects of a hard Brexit and the threat of introducing tariffs on imports of cars from the EU to the US.

Year-on-year growth of real GDP and exports (%)

f1

Source: Eurostat

In the long-term, high R&D spending (3.02% in 2017, the fourth highest in the EU) represents a positive factor for growth. Furthermore, this share will most likely grow as R&D is one of the priorities of the current government coalition. Challenges to this growth come from demographic development and the low rate of investment (especially on the government side), which can have a negative impact on productivity. ERA estimates the long-term growth potential of the German economy between 1 and 1.5%.

Public debt to fall below the 60% threshold for the first time since 2002:

At the level of public finances, Germany continues its strong consolidation. According to preliminary estimates, debt to GDP declined to 60.1% in 2018. This is just above the EU Maastricht criteria (60%), which is almost certain to be reached in 2019. This will be the first time this level is reached since 2002. In 2010, Germany's public debt was above 80% of GDP. Consolidation in Germany has been one of the strongest in the EU.

Dynamics of government debt (% GDP) in Germany and its peers since 2010 (2010=100)

f2

Source: Eurostat, European Commission

In addition to trying to set an example within the EU, the decrease of public debt was also helped by the constitutional law on a balanced budget, which stipulates the cap of the structural deficit at 0.35% for the federal government and 0% for the individual states (this will take full effect for individual states in 2020). Germany has also been recording budget surpluses since 2014 thanks to this rule (preliminary estimates for 2018 report up to 1.6% of GDP). ERA expects the continuation of compliance with this rule, which will translate into an ongoing sharp decline in debt indicators. In the long-term, this balanced budget rule should help keep public finances at bay for future challenges stemming mainly from negative demographic developments.

However, the consolidation of public finances comes at the expense of public investment, which has reached around 2% in recent years (2.2% in 2017). Lower levels of investment are reported only in the cash-strapped economies of Spain, Italy, and Portugal. Low public investment is one of the reasons for lackluster productivity growth. After the debt-to-GDP ratio drops down under 60%, the German government will be able to increase public investment. However, ERA expects it to remain well below the unweighted EU average of 3.2% of GDP reported for 2017.

Low private sector debt:

The debt of the private sector is low compared to most EU countries. In the third quarter of 2018, the debt of non-financial companies and households reached 108% of GDP, the lowest among all EU countries except for the former Eastern bloc countries; the EU unweighted average is 158%. Although this indicator has been slightly increasing in recent quarters (mainly due to the corporate sector), the credit-to-GDP-gap is around zero, according to BIS. This means that the private sector balance sheets are sound. In this context, the risk resulting from a sharp increase in housing prices (5.4% in Q3 2018) is low for the stability of economy and the financial sector.

Private sector debt-to-GDP ratio (%) in Germany and the Eurozone

f3

Source: Eurostat

Banking sector indicators are mixed. Although banks' capital adequacy has increased significantly since the crisis, banks' capital cushions in Germany are lower than the EU unweighted average (CET 1 ratio 15.8% vs. 17.4% in Q3 2018). These are also negatively affected by low profitability, which is the second lowest in the EU just behind Greece; return on equity stood at 3.3% in Q3 2018, while the unweighted EU average was 6.7%. On the other hand, German banks report high asset quality, with the NPL ratio being only 1.4% and is so one of the lowest in the EU. Overall, the financial sector's resilience can be considered adequate.

High current account surpluses are expected to persist:

Germany's high competitiveness – to a certain degree a result of the undervalued real effective exchange rate – coupled with a strong propensity to save, has resulted in sizeable current account surpluses. This decreased slightly in 2018 from 8% to 7.8% due to weaker exports, but still remains extremely high. ERA expects the surplus to remain above 6% in the coming years, which, according to the EU, is considered excessively high. Stronger acceleration in wage growth and a sharp rise in domestic investment could reduce the surplus, but this scenario is unlikely.

Current account balance and trade balance (% GDP)

f4

Source: Statistisches Bundesamt, IMF

Forward-looking factors of rating assessment

Germany has very high governance indicators. Political stability has decreased somewhat in recent years.

Very high governance indicators amid declining political stability and absence of violence:

Germans have very high trust in their institutions. This is illustrated by very high scores in the World Governance Indicators released by the World Bank. The political stability and absence of violence/terrorism indicator is, however, declining. In 2017, it was the lowest since at least 1996 (when the World Bank started publishing the indicator) and scored below the EU-average. The main reason seems to be the increase in violent crimes in recent years. However, despite the decline, the political stability and absence of violence/terrorism indicator is still well above average on the global scale.

Selected World governance indicators for Germany and average for EU countries (ERA score 1-10):

f5

Source: World Bank, ERA

Outlook: Stable

The outlook has been assigned based on expectations of a soft landing of the global economy, political stability in the Eurozone, and the government's adherence to its debt rule.

The Stable outlook assumes that the rating will most likely stay unchanged within the 12-month horizon.

Key assumptions

• Government's adherence to the fiscal rule;

• Political stability in the Eurozone;

• Soft landing of the global economy.

Potential outlook and/or rating change factors

A negative rating action may be prompted by:

• Substantial deviation from the fiscal rule putting the debt-to-GDP ratio on an upward trajectory;

• Material decline in exports above 20% year on year.

Appendix 1. Peer-analysis materials. Stance among the peer-group sovereigns

General government debt/GDP (%)

f6

Source: European Commission

General government balance (% GDP)

f7

Source: European Commission

Appendix 2. Major sovereign indicators

Indicators

2014

2015

2016

2017

2018_E

2019_F

GDP, bln EUR

2939

3049

3160

3277

3386

3480

GDP growth rate, %

2.2

1.7

2.2

2.2

1.4

1.1

GDP per capita, ‘000 EUR

36.3

37.3

38.4

39.6

40.9

41.9

Population, mln

81.0

81.7

82.3

82.7

82.9

83.0

Unemployment, %

5.0

4.6

4.1

3.8

3.5

3.2

Consumer inflation, year-average, %

0.8

0.7

0.4

1.7

1.9

1.3

External debt to GDP, year-end %

153

150

151

145

143

141

Public debt to GDP, %

74.5

70.8

67.9

63.9

60.1

57.0

Gross Domestic Investment to GDP, %

19.6

19.2

19.7

20.1

21.2

21.1

International reserves, bln EUR

159

160

176

167

173

178

Trade balance, bln EUR

214

244

249

248

228

202

Exports, bln EUR

1124

1194

1204

1279

1318

1359

Imports, bln EUR

910

949

955

1031

1090

1157

Current account to GDP, %

7.5

8.9

8.5

8.0

7.8

7.4

Appendix 3. List of material data sources

International Monetary Fund

World Bank

Eurostat

The Bank for International Settlements

Eurostat

European Commission

Deutsche Bundesbank

European Central Bank

Regulatory disclosure

The unsolicited credit rating and outlook were issued in accordance with ERA methodology for sovereign entities in the version from July 4, 2018 (available at www.euroratings.co.uk, section Methodology). In the same section is a rating scale including an explanation of the importance of each rating category and a default definition. Information on the rate of historical failure is available at www.cerep.esma.europa.eu, and the explanatory statement of the meaning of those default rates is available at www.euroratings.co.uk (Regulatory Framework/Disclosure). This rating is issued as an unsolicited rating, i.e. was not initiated by the rated entity or a related third party. The rated entity did not participate in the rating process and the information and documentation for its development was obtained from publicly available sources in accordance with ERA methodology. ERA did not have access to the rated entity’s internal documents. ERA, in the context of routine care, verified all sources entering the rating process. ERA considers the scope and quality of the information entering the analytical process to be sufficient to assign a credit rating. The disclosure of the unsolicited rating and outlook was preceded by the approval of the Rating Committee. No actual or potential conflicts of interest have arisen. Since July 30, 2012, ERA has been a registered credit rating agency according to Regulation (EC) No 1060/2009 of the European Parliament and of the Council of September 16, 2009, on credit rating agencies. The rated entity was notified on April 10, 2019, and after the notification there were no changes or amendments in the rating. The rating was first released for distribution on October 12, 2018.

Download pdf:

Germany affirmation_12.04.2019.pdf

Approved by the Rating Committee:

Zuzana Hrebičková, Acting

Head of credit rating analysts

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