Germany/Slowdown

1. *Note prepared in a freelance capacity by Amír Khan(Email: amir.khan.uk0709@gmail.com) | May 2019
Germany – How Worrisome is the Country’s Recent Slowdown?*
ermany has over the years come to be seen as Eurozone’s most dependable
growth engine and by virtue of its size – it accounts for around a third of the
Eurozone economy – it has a significant bearing on the economic prospects
of the wider Eurozone region. As such, the recent slowdown in the country’s economy
has not only been felt on the domestic front but, more importantly perhaps, has taken
a toll on the wider Eurozone economy as well. Against this backdrop, the purpose of
this note is to assess the severity of the slowdown in the German and to, a lesser
extent, the Eurozone economy. Beyond this, it will elaborate on some of the factors
that have underpinned this development, as well as on what policymakers can do
cushion the impact of the recent slowdown.
1. Germany’s growth engine starts to sputter…
After enjoying a pretty smooth run for much of the past ten years or so, the German
economy hit a stumbling block last year, thanks to the shock sustained by the country’s
external sector, particularly on the industrial/manufacturing side, from various sources
including the slowdown in the Chinese economy and international trade, the impact of
environmental regulation on the country’s automotive sector and, not to mention
Brexit, which has negatively impacted German industry through the sentiment
channel. Reflecting these developments, the growth of industrial orders has been on
a downward trajectory since the latter part of last year (see Chart 1), though there has
been a tentative rebound according to the latest data for March. Meanwhile, survey
evidence, including the widely-followed Ifo business climate index, has not fared much
better either, with the “expectations” component of the index leading the declines. This
would appear to suggest that businesses remain cautious about how quickly they
expect some of the current uncertainties facing, in particular, the industrial sector of
the economy to start to lift.
G

2. *Note prepared in a freelance capacity by Amír Khan(Email: amir.khan.uk0709@gmail.com) | May 2019
On the back of these developments, the widest measure of economic activity, gross
domestic product (GDP), for Germany declined in Q3 of last year by 0.2% and was
essentially flat in the following three months (see Chart 3). While this means that
Germany avoided a technical recession during the course of last year – defined as
two consecutive quarters of negative growth – the point to note is that the miss was
very narrow indeed. For the Eurozone as a whole, while GDP growth also took a hit
through the latter part of last year, the scale of the setback was somewhat more
tempered, in large part because the likes of Spain and France continued to hold up
well, thanks to strength of domestic demand.
Looking ahead, while more recent data for Germany – not least the Q1 GDP print
which rose unexpectedly by 0.4% q/q – suggests that it, and indeed the rest of the
Eurozone, seem to have rebounded rather strongly at the start of this year, the
underlying situation particularly in the industrial sector of the German economy
remains uncertain. Indeed, reflecting such uncertainties, the EU Commission as part
of its forecast update this month reduced its expectations for German full year growth
to 0.5% y/y for this year and 1.5% y/y for next (see Chart 4), which represents
downgrades of 1.3 percentage points and 0.3 percentage points respectively. As part
of this exercise, the Commission also slashed the growth forecasts for the Eurozone
as whole, though the scale of downgrades in this case were somewhat more modest,
thanks to region’s lesser reliance on external trade.

3. *Note prepared in a freelance capacity by Amír Khan(Email: amir.khan.uk0709@gmail.com) | May 2019
2…As former tailwinds turn into headwinds….
So, what has gone wrong with the German industrial machine? Here, as we alluded
to above, the blame lies across the following three areas:
i) Slowdown in international trade/China
Germany’s economy – with its relatively high reliance on the manufacturing sector –
is Europe’s most formidable exporter both in both absolute terms and as share of GDP
(see Chart 5) and ranks number three globally behind China and the US. This
openness to trade has meant that the slowdown in international trade, which gained
traction through last year, has hit the country particularly badly.
There are several factors at play here. First – and foremost – China's economic
slowdown through 2018 has weakened demand for foreign goods and it's an important
market for Germany (see Table 1). Additionally, in terms of export orientation,
Germany happens to specialise in the production of high value-added goods, including
capital goods and machinery (see Table 2), which have borne the brunt of the recent
slowdown in the Chinese economy, as well as the softening in global trade more
generally, thanks in large part because of the heightened trade tensions between the
US and China in which other countries have also become embroiled.

4. *Note prepared in a freelance capacity by Amír Khan(Email: amir.khan.uk0709@gmail.com) | May 2019
Also of note here is President Trump's tariffs on steel and aluminium which have
adversely affected German and Eurozone exports of these products. Beyond this, the
possibility that he might impose tariffs on cars going forward could do a lot more
damage to Germany given that the “transportation” segment as whole makes up more
than 20% of Germany’s total exports.
i) Brexit blues hit home
UK’s Brexit vote has not done Germany any favours. Indeed, the uncertainty
associated with Brexit is recurring concern cited by German firms in their survey
responses. This not all that surprising given that the UK is Germany’s fourth largest
trade partner to whom it exported almost US$95bn in 2017.
In terms of the likely impact of Brexit on different sectors of the German economy, the
automotive sector in particular stands out. Indeed, as at 2017, Germany exported a
total of some €19bn passenger cars to the UK – making it the country’s second most
important market after the US. Given this backdrop, a key risk according to Deloitte is
that aside from short-term disruptions of supply chains for some German car
manufacturers, a hard Brexit could lead to a drop of around 30% for German car sales in
the UK.
ii) Short-term factors
There have also been some temporary factors that have contributed to Germany’s
problems. New emissions testing procedures set back car production last year, while
low water levels on the River Rhine – which is a very important transport route for
German industry – restricted cargo traffic for a certain period.
3. Can policymakers come to the rescue?
With the German government currently running a budget surplus (1.7% of GDP as
2018), perhaps the most logical way to stimulate the German economy – and cushion
the impact of the recent slowdown – is to increase government spending. That said,
there is a deep-seated political resistance in Germany to running budget deficits and
this has been reinforced by the experience of the European debt crises earlier in the
decade.
Meanwhile on the monetary policy front, the ECB already has interest rates at or close
to the lowest level that they can be, which implies that there is little or no room to cut
them any further. Indeed, its main rate is zero, while the deposit rate – which is the
rate commercial banks get for parking their money overnight with the ECB – is
negative.
Also of note here is the fact that, in terms of unconventional policies, the ECB halted
its “quantitative easing” policy of buying financial assets with newly created money at
the end of last year. While reviving this is remains a possibility, there are certain
complications worth bearing in mind. For some assets, the ECB is approaching the
maximum amount it wants to hold to avoid distorting the market too much. And
politically it would be difficult to sell this policy especially in Germany which where the

5. *Note prepared in a freelance capacity by Amír Khan(Email: amir.khan.uk0709@gmail.com) | May 2019
programme was always viewed with suspicion. “Printing money” as the programme is
sometimes called can conjure up fears of high inflation and Germany has had seriously
disruptive period of high inflation during the inter-war period, which continues to linger
in the minds of German policymakers.
4. Taking stock - Is there a silver lining?
The unexpected slowdown of the German economy last year took most observers by
surprise. While it appears to have bounce back from this “soft patch” at the start of this
year, the point to note it will not necessarily be plain sailing from hereon in as trade
tensions between the world two largest economies – US and China – appear to have
taken a turn for the worst recently and – if they’re allowed to continue on this course –
they could further undermine global trade growth and, hence, the prospects of open
economies such as Germany. That said, the recent slowdown of the German economy
should not be taken completely out context, not least because of the following three
factors, which could be viewed as its “silver lining”:
 Although the worst of the industrial-led slowdown of the German economy appears
to have passed, the point note is that the downward pressure on the overall
economy would have been worse had it not been for the welcome strength of the
services sector of the economy. This is set to continue thanks to the resilience of
the country’s labour market and the willingness of consumers to go out and spend.
 Germany went into the current slowdown with its fiscal house in order, and should
the economic situation worsen much further, it has the option of turning on the
fiscal taps, though there is political reluctance to do this at this stage.
 While the UK’s Brexit vote represents bad news for the German economy as a
whole, there’s a corner of the market that is emerging as a winner from this
development: the financial services services sector. Indeed, since the Brexit vote,
a number financial institutions have announced their intention of shifting their
European base from London to Frankfurt, which if realised will stands to be a boon
for the German financial capital.
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