ABOUT GERMANY

The German Economy 2006

As Europe’s largest economy and second most populous nation, Germany remains a key member of the continent’s economic, political, and defence organizations. European power struggles immersed Germany in two devastating World Wars in the first half of the 20th century and left the country occupied by the victorious Allied powers of the US, UK, France, and the Soviet Union in 1945. With the advent of the Cold War, two German states were formed in 1949: the western Federal Republic of Germany (FRG) and the eastern German Democratic Republic (GDR). The democratic FRG embedded itself in key Western economic and security organizations, the EC, which became the EU, and NATO, while the Communist GDR was on the front line of the Soviet-led Warsaw Pact. The decline of the USSR and the end of the Cold War allowed for German unification in 1990. Since then, Germany has expended considerable funds to bring Eastern productivity and wages up to Western standards. In January 1999, Germany and 10 other EU countries introduced a common European exchange currency, the euro.

Germany ‘s affluent and technologically powerful economy – the fifth largest in the world – has become one of the slowest growing economies in the euro zone. A quick turnaround is not in the offing in the foreseeable future. Growth in 2001-03 fell short of 1%, rising to 1.7% in 2004 before falling back to 0.9% in 2005. The modernization and integration of the eastern German economy continues to be a costly long-term process, with annual transfers from west to east amounting to roughly $70 billion. Germany’s aging population, combined with high unemployment, has pushed social security outlays to a level exceeding contributions from workers. Structural rigidities in the labour market – including strict regulations on laying off workers and the setting of wages on a national basis – have made unemployment a chronic problem. Corporate restructuring and growing capital markets are setting the foundations that could allow Germany to meet the long-term challenges of European economic integration and globalization, particularly if labour market rigidities are further addressed. In the short run, however, the fall in government revenues and the rise in expenditures have raised the deficit above the EU’s 3% debt limit.

(Source : The world fact book)

Although there was a disappointing fourth-quarter, real GDP figures have managed to dent Germany’s confidence to any great extent and a growing number of analysts see 2% growth this year as likely.

The federal statistics office’s breakdown of orders from abroad into Emu and non-Emu countries provides interesting information. According to this, the boost to German manufacturing in recent months has not come, as might have been expected, in the form of orders from growth regions such as North America, Asia or Central and Eastern Europe (nor from the OPEC countries), but from other countries in the euro zone. The breakdown reveals that demand from the boom regions has been virtually stagnating since the middle of 2005, with some fluctuations. However, it would probably be premature to conclude that demand from Germany’s European neighbours is really on the mend. The figures have in fact probably been distorted by the surge in Airbus orders, as the orders to Hamburg come from the company’s headquarters in Toulouse and thus count as orders from France.

The more important question than the impact of extraordinary factors such as the weather, which often distort the quarter-on-quarter results, is whether the present upturn is the start of a sustained recovery. We still have our doubts on this point. True, this year should again see strong growth in exports and investment in machinery and equipment, and after more than 10 lean years the construction industry should stabilise. However, the decisive factor will be private consumption still failing to take off again, despite a good retail result in January.

The economy is expected to ease off a little over the course of the year. There is still a predicted real GDP growth of 11.2% this year and 1% in 2007.

Strong rise in imports and exports

No matter where orders for German industrial goods come from, foreign business is flourishing. German exports continued to rise in January, achieving +3.3% month on month, after a somewhat over momentum during the final quarter of 2005.

While the strong global economy had pointed to exports benefiting, the marked rise in imports came as something of a surprise, given that domestic demand remains muted. They too were up 3% month on month in January, following a strong increase in December consequently, in January at least the nominal trade balance is smaller than the fourth-quarter average, i.e. in purely mathematical terms foreign trade will not have made any positive contribution to growth so far during the first quarter. However, the forecast of 0.7% real GDP growth in the first quarter are on the downside, together with the severe winter hitting the construction sector badly.

Inflation set to fall

Our scepticism about private consumption is not altered by the fact that we envisage consumer prices rising only a little this year. While the inflation rate did exceed 2% in February, it has dropped beneath this level in March for the first time since last summer, and should continue to retreat over the coming months.

Energy prices are of course the key to this forecast. We are expecting the price of a barrel of Brent blend to drop back to around $53 over the course of the year, whereby we have raised our oil price forecast a little in view of somewhat stronger global economic growth being expected after all. However, even with a stable oil price, energy prices would contribute less and less to overall price increase as the surge that occurred last year gradually disappears from the year-on year comparison.

The decisive factor, however, for our inflation forecast of a revised 11.4% so far below the consensus – we have raised it a quarter of a percentage point on account of the higher oil price expected – is that core inflation is unlikely to accelerate much. When the effect of government measures and higher energy prices is excluded, consumer prices have risen by less than 1% year on year for the past three and a half years. This was probably due to the euro’s gains and to minimal growth in unit labour costs, which actually fell in 2004 and 2005.

We are assuming that unit labour costs will hardly rise this year or next, and in fact they are likely to fall this year. Consequently, despite some indirect impact from higher energy prices, the core inflation rate should remain extremely moderate. While next year’s VAT increase will push inflation up, falling energy prices and modest increases in other prices will ensure that the rate amounts to no more than 11.2%.

(Source : Commerzbank – Economic Research)
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