GERMANY RISK ASSESSMENTS
|One Year Ahead||Five Years Ahead|
|Risk Band||V. Low||V. Low||Low||V. Low||Low||V. Low|
Anti-Euro Voices Grow Louder
The coalition government pairing Angela Merkel’s center-right Christian Democratic Union (CDU) and its small sister party, the Christian Social Union (CSU), with the center-left Social Democratic Party (SPD) has survived eighteen months of a four year term to 2017, but not without the petty disagreements and occasional bitter feuding that is symptomatic of a bridging of the political divide.
The parties have worked together previously in government during 2005-09, and although the SPD’s leader and Minister for Economic Affairs and Energy, Sigmar Gabriel, a newer face, has proved a rather difficult and combative partner for Merkel, an early election is not on the cards. The two have shown a preference for typical German pragmatism in resolving their differences and have sided on most foreign policy issues, including how to handle Russia and Greece, in spite of Gabriel occasionally stepping out of line.
The coalition partners have also remained consistently stable in the opinion polls. The CDU/CSU still has a 16-17 point advantage over its rivals, benefiting from Merkel’s ability to go beyond the narrow popularity of her own centrist voters as Germany’s preferred stateswoman. The SPD is still commanding only a quarter of the vote, but that is broadly similar to its 2013 election result and the party is comfortably better off than the Left and the Greens, which are each polling a 9-10% share.
A series of state elections held since the government was formed have nevertheless provided some discomforting readings for the governing parties, not least in terms of highlighting the resentment among a sizeable minority towards the euro zone given the financial implications for German taxpayers of bailing out errant nations.
The elections held last September in Brandenburg and Thuringia in eastern Germany went much as expected in terms of the overall winners. Brandenburg returned a red-green coalition led by the SPD, while in Thuringia the CDU won, managing to claim four additional seats, partly by marginalizing the FDP liberals, which had performed poorly at the federal elections, and lost all seven of their state representatives.
Although the SPD also saw a third of its state parliament electives ejected in Thuringia, the bigger story concerned the stunning performance of the Alternative for Democracy (AfD), a single cause, anti-euro (but not overtly anti-European Union) party seemingly widening its appeal to those questioning not only the implications of large bailouts for Greece and other euro zone member states, but also the divisive issue of immigration. The AfD snapped up 11 seats in each of the Brandenburg and Thuringia state parliaments for the first time, taking a larger share of the vote than its pre-election polling had signaled and staking a claim for a federal level shake-up in 2017 should it become a larger thorn for the mainstream parties to deal with.
At the Saxony election held in August the AfD took 14 seats, but on only a 9.7% share of the vote, sparking some commentators to note its inability to make headway. The party also took eight seats in its first proper test of support in the west, at the Hamburg state elections in February 2015, but on an even lower share of 6.1%. The FDP managed to retain its nine seats there, signaling a potential fightback is on the cards, while the two governing parties suffered from gains for the Left and the Greens amid a splintering of the political spectrum similar to that evinced in other EU member states. The SPD lost its majority in Hamburg, but it was an eight seat loss for the CDU which sent a warning to Merkel that her position over Greece and other recalcitrant euro zone states may be more pressing than any concerns over the domestic economy.
Support for the AfD has been upheld by unease over immigration and the marginalizing of the far-right, which has seen both extremists and more mainstream xenophobic sympathizers unite in support of the anti-Islamist, anti-immigration Pegida movement orchestrating a series of demonstrations mushrooming from their rather low-key beginnings in Dresden last October to demos involving some 25,000 supporters at their peak in January.
Pegida’s fall proved to be rather swifter than its rise when several of its founders resigned in the wake of social media threats and even larger protests from opposing left-wing groups. However, the rise of xenophobic and Islamaphobic tendencies reflects not only the changes in Germany’s socio-economic mix in recent years, culminating from an influx of immigrants and asylum-seekers, but also the disdain for European ideals which could yet see AfD and perhaps other populist parties influence the outcome of the next federal elections.
Holding Back Competitiveness
In the meantime friction between the governing parties is likely to increase as a result of these trends as each party positions itself on key issues and plays to their grassroots. Unfortunately this does not always deliver optimum outcomes. The minimum wage debate provides a case in point.
A majority of supporters of both parties are still in favor of the legislation, which was introduced as a condition of forming the coalition at the behest of the SPD. Initially set at €8.50 per hour the minimum wage (the first to be introduced in Germany) has had no discernible negative impact on prices or employment. Yet there are clearly teething problems associated with the form-filling required to comply with the law, on top of the grievances from small business taking it on the chin regardless of their bottom-line profitability.
The huge administrative burden involved in complying with the minimum wage means exact working time records of every employee must be filed every week to the authorities, which is clearly a problem for small and medium-sized enterprises. A minimum wage has worked fairly well in other countries, but the longer term effects on competitiveness are unknown, especially as demand for it to be raised increases and countries compete in a global marketplace.
Pressure from the CDU/CSU to make amendments to the law are being staunchly resisted by the SPD Labor and Social Affairs minister, Andrea Nahles, although it seems likely a minor reform will be agreed if only to alleviate the bureaucracy. Yet there are questions remaining about the degree of over-regulation generally in Germany, including planning restrictions harming competitiveness and some other rather antiquated rules and regulations that seem out of line with a modern, international, market economy.
Germany ranked 14th globally in the World Bank’s latest Doing Business report for 2015, with the government making it harder, not easier, to start a business and register property. The German Chambers of Commerce and Industry has noted, moreover, 35 measures agreed by this government which it says will have negative effects on innovation and investment, which are the bedrocks sustaining a country’s long-term growth potential. They include such facile impediments as limits on temporary work and bans on reading work-related e-mails out of normal working hours. On top of that the powerful metalworkers union, IG Metall, has managed to gain a 3.4% wage rise this year acting as a benchmark for other sectors.
Changes to the Banking Law
The government is also planning to amend existing banking legislation by relegating the importance of senior bondholders in the chain of creditors to be repaid (i.e. bailed-out) during a bankruptcy resolution. In effect it means senior bondholders would be more at risk of losses before other unsecured creditors – the wholesale depositors and counterparties trading in derivatives and structured notes – providing a structured bail-in hierarchy to aid the resolution process which fits with the EU’s Bank Recovery and Resolution Directive and other capital requirements.
There are no grave threats from the move; indeed the precise details of the changes will not be known until late summer when the amended German Banking Act becomes law, allowing time for lobbying from the industry to ensure a suitable framework is agreed. On these plans, the risks tied to the losses involved are mitigated by the increased capital buffers, although there could be some negatives in terms of increased funding costs and/or reduced market access most experts suggest.
The return to stronger growth during the latter months of 2014 brought welcome relief to the government and investors alike, concerned by the very weak trends which had set in earlier in the year. GDP grew in real terms at a lively 0.7% pace during the fourth quarter (seasonally-adjusted), and by 1.5% year on year. It partly signaled the effects of the Russian trade embargo were either not as damaging as expected, or dissipating as exporters reorient to other markets, culminating in a 1.6% annual average growth rate for 2014, the highest for three years.
Export volume and investment spending moved up a gear last year – and will underpin Germany’s longstanding strong current account position projecting a surplus of 7-8% of GDP for 2015/16. However, as import volume also increased at a faster pace in 2014 domestic demand was the key growth-driver and is likely to remain so with decent investment prospects and real wage growth underpinning consumer spending. In the fourth quarter private consumption increased by 0.8%, while construction (growing by 2.1%), and machinery and equipment outlays to a lesser extent, provided platforms for the economic revival.
Setbacks are possible, not least in terms of the manufacturing sector which is vulnerable to a slowdown in the emerging markets in which German exporters have gained market share. However, the European Commission’s economic sentiment indicator for Germany leapt to 105.1 in March, its highest level since last July, on the back of improving manufacturing sentiment and a strong rise in consumer confidence.
Coping With Deflation
The latter reflects declining oil prices boosting the real value of wages and salaries, lowering the inflation rate quite dramatically, from annual rises averaging more than 2% only a few years ago to almost zero by the end of last year. Monthly data released for 2015 to date show mild deflation emerging, which with similar trends in other euro zone states explains the European Central Bank’s motivations for rolling out the new quantitative easing (bond-purchase) program into 2016 which will aid export growth outside the euro zone, having already had a substantial impact on the euro’s value which is predicted to remain at a weakened level against the dollar and pound-sterling.
Whether deflation persists or low inflation returns depends on how long oil and other commodity prices remain depressed. Competitive pressures on goods and services prices, compounded by the negative output gap, continue to impart a damper on corporate pricing behavior. Inflation expectations compiled by Euro Zone Barometer, a monthly survey of independent economic experts, depicts a zero inflation rate for this year, rising to 1.2% in 2016, which seems a sensible ballpark. In that light, and with the unemployment rate falling to 4.8% (harmonized) in February – with barely more than 7% of the under-25s in Germany without work, and falling prices delivering real wage growth – consumer spending can leverage growth back up to 2% this year, especially since interest rates on loans and savings have fallen to record lows.
Germany’s appeal would be rocked if Greece exits the euro zone, causing the economic recovery to stall. Arguments rage as to whether such an event would spark a snowball effect, ultimately leading the single currency project into complete dissolution. We would expect a shared Deutsche-currency to be preferred by the stronger member states (Austria, Belgium, the Netherlands and so on) and the impact on Germany per se only a temporary dislocation.
Germany’s longer-term appeal would not be completely crushed in the light of its favorable fiscal position. The government has achieved budget balance and is able to concede some expenditure concessions for pensioners and benefit recipients, and yet remain within a tight expenditure envelope targeting small surpluses (as a proportion of GDP) into the medium term. This will foster the gradual reduction of the debt burden below 70% of GDP on a gross basis by 2016, which may be adversely affected should the economy slide but would not necessarily imperil Germany’s historical strengths.
Its strong institutions, the political will to maintain unity in Europe, and external surplus will stand Germany in good stead should the single currency disintegrate. Europe-level preparations have put a firewall around the remaining countries if Greece can no longer remain a member, which we believe is still a 50:50 proposition looming in the next few months. There are bigger risks to assets from a disorderly unwinding of the Greek crisis and from unforeseen banking sector liabilities – on that score the Austrian crisis we documented last month is a concern, but not a hugely threatening one. Meanwhile, an unlikely but not entirely inconceivable spiraling of the conflagration in Europe extending from the war in eastern Ukraine is another factor potentially sparking a sell-off.