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Germany retains AAA credit rating but Europe still faces entrenched economic problems

By Dean Carroll

The strength of the German economy as Europe’s powerhouse has been reiterated by one of the ‘big three’ ratings agencies. Standard and Poor’s affirmed the country’s AAA credit rating, noting that the financial outlook for Germans was “stable” despite the threat of stagnation in the wider European Union.

A spokesman for S&P’s said: “In our view, Germany has a highly diversified and competitive economy with a demonstrated ability to absorb large economic and financial shocks. Germany’s public finances and strong external balance sheet will continue to withstand potential financial and economic shocks.”

The ratings agency praised the “government’s track record of prudent fiscal policies and expenditure discipline”, adding: “After slowing to an estimated 0.5 per cent real gross domestic product growth in 2013, we forecast the German economy will expand steadily over the medium term averaging above 1.5 per cent real GDP per capita growth in 2014-2016.

“Germany’s economic model continues to be driven by high net exports as well as relative competitiveness achieved from years of corporate restructuring, wage restraints and high savings rates. These factors have also enabled the country to generate sizable trade and current account surpluses, which have led to a solid net external creditor position – including non-debt assets and liabilities. In addition, 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.”

However, S&P’s warned the nation’s leaders to expect only a “modest” expansion in consumer confidence and pointed to the weakness of some of the country’s trading partners as a threat to the current high demand for German goods and services. “As a result, we forecast the current account surplus to gradually shrink to 4.4 per cent of GDP by 2016, from 7 per cent in 2012,” said the ratings agency.

“Germany is primed for a period of balanced general government budgets. We believe balances will stay closely aligned to the new constitutional target of limiting structural federal government net lending to below 0.35 per cent of GDP. In detail, we forecast deficits to average 0.17 per cent of GDP in 2014-2016, a performance facilitated by the favorable growth environment.

“We note that similar statutory fiscal constraints have had a poor track record in several other countries but we believe that this institutional framework may be more effective in Germany because of long-standing public and political support for fiscal discipline. As evidence, the Social Democrats’ return to government does not appear to challenge the medium-term fiscal plan. The constitutional limit should also, in our view, mitigate the consequences of Germany’s federal system not typically lending itself to swift and efficient policymaking.

“As a result of small deficits, we expect Germany’s net general government burden to gradually decline to closer to 71 per cent of GDP in 2016 from its current 77 per cent. Under our methodology, this figure does not include liabilities arising from the various multilateral financial support mechanisms in the eurozone, which we consider to be contingent liabilities. Germany’s European Financial Stability Facility and European Stability Mechanism liabilities could amount to as much as €235bn or about 9 per cent of GDP. However, this figure assumes the worst-case scenario; that the ESM would lend the maximum amount, that all borrowers would default, and that there would be no recovery at all.

“Since this is a remote prospect, we currently do not consider this an immediate risk to the rating. Meanwhile, we believe Germany can carry a somewhat higher debt burden than many peers given its diverse and resilient economic structure as well as its access to low-cost capital market funding.”

Although the ratings agency raised the prospect of Germany needing to provide further financial support to its troubled single currency partners “and the likelihood of an exogenous shock to Germany’s economy”. The spokesman added: “From a monetary perspective, we consider Germany’s eurozone membership to reduce its monetary flexibility but we acknowledge that Germany has benefited from the euro’s status as a reserve currency – as well as from the credibility of European Central Bank monetary policy. Germany’s eurozone membership has also largely shielded the German tradables sector from currency appreciation pressure, supporting an increase in the export share to 52 per cent of GDP in 2013 – from an average of 26 per cent of GDP in the five-year period preceding the introduction of the common currency.”

Dean Carroll is editor of Policy Review. Follow him on Twitter @poljourno and follow Policy Review @Policyrev

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