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 severe economic shock from the global Coronavirus Disease (COVID-19) pandemic and the impact on its fiscal position. The German economy is set to contract sharply in 2020, before posting a recovery in 2021. In response to the economic crisis, the government is using its fiscal space and the flexibility provided within its fiscal framework. It has adopted a substantial support package, which will turn its fiscal surplus into a large deficit in 2020 and increase its public debt ratio significantly this year. Nevertheless, DBRS Morningstar expects government finances to return to a balanced position and the government debt ratio to resume its downward trajectory over the medium term.

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. 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

German Economic Growth Has Been Hit by The Coronavirus Pandemic

The performance of the German economy weakened in 2019, with real GDP growth at just 0.6% compared with 1.5% in 2018. On the production side, the slowdown was more pronounced in the industrial sector, with auto manufacturing posting the sharpest decline among main manufacturing sectors. The export-oriented German industry was affected by weak global trade and other external uncertainties. Some signs of recovery in industry started to emerge at the beginning of 2020, but the spread of the coronavirus pandemic globally disrupted any potential recovery.

Growth forecasts point to a severe contraction in 2020, followed by a recovery next year. Containment measures, imposed from mid-March until end-April to limit the spread of the virus, together with disruptions in external trade and global supply chains, have had a severe impact on economic activity. As Germany has been successful in containing the virus and associated mortality, most restrictive measures have been gradually lifted, but the economy is still operating below capacity. In its latest projections, the federal government is forecasting the economy to contract by 6.3% in 2020, before growing by 5.2% in 2021 driven by pent-up demand. It expects output to return to pre-crisis levels by 2021.

The near-term growth outlook is subject to uncertainty. It depends on the recovery of export markets and global supply chains, the rate of infection remaining contained, and the effectiveness of the economic policy response. Germany’s industrial sector, well integrated into global and European value chains, could suffer from a further weakening in external demand or renewed trade tensions. Domestically, the German States are operating an emergency mechanism that could lead to a tightening in restrictive measures if infection cases surge again. To deal with the economic fallout, the government is implementing measures to support affected businesses and households. These include enhanced access to the short-time work scheme (Kurzarbeit), which is aimed at limiting job losses. The government is forecasting the harmonised unemployment rate to rise to 3.8% in 2020 from 3.2% in 2019. While DBRS Morningstar expects the support measures to be effective, the near-term outlook is clouded by considerable uncertainty.

Nevertheless, Germany’s large, competitive and diverse economy supports its resilience. The healthy position of households, firms and the public sector enable them to absorb shocks and support Germany’s long-term growth prospects. A key long-term challenge for the economy is the impact of a declining population on potential growth. The government estimates growth of potential output at 1.6%. One of the government’s objectives is to enhance the growth drivers of the German economy. To achieve its objective, the government is increasing investment in digital and transport infrastructure, education and research. Another long-term challenge for the economy is the structural changes in the car industry as it shifts to the production of electric cars.

Germany Has Adopted One of The Largest Expansionary Fiscal Positions Among Advanced Economies

Germany’s prudent fiscal policy and financial flexibility have allowed the federal government and the German states (Länder) to adopt a comprehensive and substantial package of measures to support the economy. In addition to the Kurzarbeit, discretionary measures and automatic stabilizers include tax relief, unemployment benefits, and liquidity assistance for small firms and the self-employed, among other measures, amounting to 13% of GDP. The government also adopted extensive loan guarantees, equivalent to 25% of GDP, through the state-owned development bank KfW and an Economic Stabilisation Fund for large-scale support for companies. More recently, the government agreed on additional stimulus worth roughly 4% of GDP through 2021 that includes reductions in consumption taxes, further support for households, additional liquidity measures, and infrastructure spending.

To finance the spending and cover a potential shortfall in tax revenues, the Bundestag approved a supplementary federal budget. Through an exception clause, it allowed the government to exceed temporarily the structural deficit limit of 0.35% of GDP (the statutory debt brake rule). This also ended the government’s commitment to a balanced federal budget – the “black zero” approach – that precluded issuing new debt.

The fiscal surplus will turn into a deficit, but public finances are expected to improve again over time. After posting surpluses at the various levels of government since 2014, the government is now forecasting a fiscal deficit of 7.2% of GDP or higher in 2020, as presented in its Stability Programme. DBRS Morningstar expects Germany to return to a healthy budget position over the medium term. Over the longer term, a key challenge to fiscal sustainability stems from the demographic dynamics reflecting the country’s declining working-age population. In response, the government has set up a ‘commission on intergenerational fairness’ to review the pension system.

As a result of the new borrowing needs, the general government debt-to-GDP ratio is set to increase significantly in 2020. After falling below 60% in 2019, the government is forecasting the debt ratio to increase to around 75%, still below the 2010 peak of 82.4% of GDP. Despite the sharp increase in debt, the government benefits from very favourable financing conditions. Germany continues to enjoy a safe-haven status. This supports DBRS Morningstar’s qualitative assessment of the “Debt and Liquidity” building block.

Financial Stability Risks Have Risen In Recent Years but Are Manageable

The Deutsche Bundesbank has identified as main financial stability risks the potential underestimation of credit risks and the overvaluation of assets, particularly real estate. Nationwide, house price increases seem to largely reflect rising household income, immigration, supply bottlenecks and supportive credit conditions. Nevertheless, there seems to be no evidence of a debt-driven property boom. Household debt remains low, debt servicing’s vulnerability to interest rate rises is limited as most mortgages are fixed rate, and homeownership is relatively low in Germany, mitigating macroeconomic and financial stability risks.

Credit standards have eased only marginally, but lending growth has picked up. To address the build-up of risks, German authorities have broadened their macroprudential toolkit to include borrower-based measures (limits on loan-to-value ratios and amortisation requirements) in recent years. The German Financial Supervisory Authority (BaFin) also activated the domestic countercyclical capital buffer last year, lifting it to 0.25% of risk weighted assets from July 2019, to enhance the resilience of the financial system. However, in March 2020, in response to the current economic crisis the ECB Supervisory Board provided temporary capital relief measures for euro area banks to increase their capacity to lend to the economy. Subsequently, BaFin reduced the countercyclical capital buffer to 0% effective from April 2020.

German banks are entering the crisis with resilient capital positions and strong liquidity. Stress test results in 2019 for the eight large banks confirm their resilience. Moreover, the majority of the Landesbanken have now been restructured, reducing risks in the banking system. However, profitability is weak and the operating environment has deteriorated with the coronavirus crisis. Net interest margin compression has put pressure on profitability amid low interest rates, constraining the ability of German banks to absorb significant increases in credit costs. While asset quality is still good, the full impact from the pandemic is uncertain, and credit costs are likely to increase significantly going forward.

Solid Institutions and Stable Political Environment Reassure Policy Continuity

Germany benefits from solid political institutions, lessening the risks associated with its more fragmented political landscape. Although the Alternative for Germany gained seats in the Bundestag and regional parliaments for the first time in 2017, 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 party 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. But, after recent unrest within the party, Kramp-Karrenbauer announced she would step down as party leader in the summer of 2020. The CDU now has to find a new successor to Ms Merkel. Ahead of the next national elections, currently planned for Autumn 2021, German politics could become less predictable than in the past. Despite some political uncertainty in the horizon, DBRS Morningstar expects broad economic policy continuity and continued support for European integration.

The External Sector Remains 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 cyclical factors in recent years have contributed to higher external account savings, structural factors – including higher household and corporate savings rates – have driven large surpluses in the current account. The current account surplus is set to decline in 2020, as exports are expected to fall sharply reflecting weak external demand, while imports could be fall less steeply.

Persistent current account surpluses, averaging 6.0% of GDP between 2002 and 2019, have enabled Germany to build up a strong net external asset position. Germany’s net international investment position stood at 71.0% of GDP at the end of 2019. This supports DBRS Morningstar’s 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 and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/362066/.

EURO AREA RISK CATEGORY: LOW

Notes:
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 (September 17, 2019) https://www.dbrsmorningstar.com/research/350410/global-methodology-for-rating-sovereign-governments.

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.

The sources of information used for this rating include Germany’s Federal Ministry of Finance (German Stability Programme 2020), Federal Ministry for Economic Affairs and Energy (Federal Government’s 2020 Spring Projection), 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 April 2020), Federal Statistical Office, Federal Financial Supervisory Authority (BaFin), ifo Institute, European Commission (2020 Spring Forecasts), Statistical Office of the European Communities, European Central Bank (ECB), IMF (World Economic Outlook April 2020), 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.

This is an unsolicited 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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/362065/.

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: June 16, 2011
Last Rating Date: December 6, 2019

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