Germany, the eurozone’s largest economy, is facing economic headwinds and is on the precipice of a recession.
Economists argue that for an economy to be technically considered as being in a recessionary period it has to have reported two consecutive quarters of negative growth. While this has not yet occurred, the German economy contracted by 0.1 per cent in the second quarter of this year after registering growth of 0.4 per cent in the preceding period. Notwithstanding the negative growth in the last quarter, economists are forecasting that the German economy will grow by 0.2 per cent in the third quarter of this year.
The economic slowdown was primarily due to exports falling at a faster rate than imports, and a marked decrease in construction. However, an increase was registered in both household consumption and government spending on a quarter-on-quarter basis.
The economic contraction can be attributed to several factors, including the ongoing trade war between the world’s two largest economies, namely the US and China, the effects of the UK’s planned departure from the European Union, together with political uncertainty caused by events such as the Italian political stalemate.
The German vehicle sector, which contributes significantly to German exports, was also a factor in the weakening of German economic growth. In recent times, German car makers have had their fair share of hardships due to the risk imposed by the ongoing trade war, which has hampered revenues, together with the emissions scandal and the ever-increasing regulatory pressures.
The German Constitution clearly states and restricts the German government from running a fiscal deficit. In other words, government expenditure has to equal government revenue at the very minimum. Historically speaking, the German government is synonymous with being fiscally prudent as it’s been able to run a fiscal surplus rather than a fiscal deficit, as is the norm with many other governments around the world.
The argument to boost government expenditure in the face of a possible recession through an increase in government expenditure is strengthened
German Finance Minister Olaf Scholz has indicated that a fiscal stimulus amounting to €50 billion could be unleashed should the country slip into a recession.
The option of amending the German Constitution in such a way as to remove the restriction currently imposed whereby the government may not run a fiscal deficit is also being weighed.
This is being considered in light of the impending predicted recession in order to have both the flexibility and fiscal ability to boost the economy in times of a weakening economy.
The German government’s argument to offset or minimise a possible recession through an increase in spending in the country is further strengthened by its low debt-to-GDP levels and the historically low borrowing costs that the German government incurs when it taps the sovereign bond market. Currently, the German government’s debt-to-GDP stands at 60.9 per cent, which is among the lowest in the eurozone when one compares to other eurozone members such as France and Italy, with debt-to-GDP figures of 98.4 per cent and 132.2 per cent respectively. Both France and Italy’s debt level are above the recommended 60 per cent imposed by the European Union.
With the entire German sovereign yield curve in negative yielding territory, the 10-year German government bund currently yields -0.68 per cent. This implies that lenders (or bondholders) have to pay the German government to hold their cash, a concept which is detrimental and perhaps even illogical to many bond investors.
The contrary is true for the German government. With such low yields the argument to boost government expenditure in the face of a possible recession through an increase in government expenditure is strengthened, as issuing more debt does not increase the government’s interest expense in servicing the debt.
However, the appetite for negative yielding paper seems to be abating, as recently the German government struggled to find buyers for a €2 billion German sovereign bond which had a zero per cent coupon and matured in 2050. The government was only able to sell €824 million (compared to a target of €2bn) of the zero coupon bond with an average yield of -0.11 per cent.
Perhaps, this could be a signal that the German government would need to sweeten its offer if it intends to stimulate the local economy through a fiscal expansion programme which will be financed via debt, as investor fatigue seems to have set in for negative yielding securities.
Within the European context, the possibility of a German economic recession will add to an already weak economic environment for the euro bloc. European Central Bank (ECB) President Mario Draghi has long called for eurozone member nations to increase their fiscal spending to deliver economic growth as the ECB has possibly reached the limits of its monetary powers to resuscitate the eurozone economy. A spillover affecting other eurozone members is conceivable should economic conditions deteriorate further in Europe’s largest economy.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.
Simon Gauci Borda is a junior research analyst at Curmi and Partners Ltd.