Global: Fitch Affirms Germany at ‘AAA’; Outlook Stable

Fitch Ratings has affirmed Germany’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘AAA’ with a Stable Outlook. The European country’s healthy credit position is underscored by a very strong fundamental, and moderate fiscal deficit among others.

Germany’s ‘AAA’ rating reflects its diversified, high-value-added economy, strong institutions and record of sound public finances, according to the rating note.

The rating is also supported by Germany’s position as the benchmark sovereign issuer in the Eurozone, which ensures very strong financing flexibility.

The track record of persistent, high current account surpluses speaks for the competitiveness of Germany’s export sector and supports its net external creditor position.

Significant Economic Slowdown: Germany has been the hardest hit of the major Eurozone economies by the energy shock and supply-chain constraints.

The shock has abated slightly, mostly due to falling energy prices and high gas storage levels across the continent combined with a warm winter, resulting in a smaller-than-expected decline in output.

“We still expect a significant economic slowdown, but we have revised our growth forecast for Germany in 2023 upwards to 0.1% from -0.5% at the time of the last rating review in October.

“Given the higher base and also our expectation for interest rates to stay higher for longer, we now expect the economy to expand by only 1.4% in 2024, down from 2.3% previously”.

In 2022, the economy grew by 1.8% in real terms though inflation pressures persist.  Inflation eased after reaching a peak of 11.6% in October 2022 (measured by the Harmonized Index of Consumer Prices, HICP) but remained high at 7.8% in March.

Fitch analysts forecast inflation to fall to 5.8% in 2023 from 8.7% in 2022.

The potential pass through of lower energy prices to inflation will be difficult to assess, as it depends on the pricing strategy of energy companies, as well as the impact from government subsidies.

The scheme is expected to come into force in March and will be paid retrospectively for January and February. Core inflation meanwhile has increased, reaching 5.4% in February from 3.4% six months before, broadly in line with the Eurozone at 5.6%.

Germany’s labour market remains very tight, as reflected in one of the highest vacancy rates in the Eurozone, at 4.4% in 2Q22.

“We expect the rate of unemployment to rise slightly due to a slowdown in job growth, to 3.2% in 2023 from 3.0% in 2022, but to stay significantly below 3.7% in 2020”.

Job creation remains robust, with employment rising on average by 2.3% in the last three quarters of the year and employment barometers of the Ifo Institute pointing in favour of workforce expansion in the short term.

Pressure on wages has so far been limited (at 2.4% in 4Q22), thanks to a gradual expiry of the negotiated wage agreements and the government’s relief measure, which allows companies to grant up to EUR3,000 in a one-off, tax-free inflation bonus.

However, current wage demands are very high, with some unions asking for as much as a 10.5%-15.0% increase in base salary, indicating a risk for the inflation path.

“We expect Germany’s general government fiscal balance to widen to 3.1% of GDP in 2023 from 2.6% in 2022. Our forecast for the 2023 deficit is lower than 3.5% at the time of the last review, mostly due to lower energy prices, which we expect to translate into smaller spending on the energy package”.

Fitch said fiscal deficit should narrow to 2.6% in 2024 and continue falling to around 1% of GDP in the long term, above the ‘AAA’ rated median for a balanced budget and Germany’s fiscal surpluses before the pandemic (five-year average at 1.4% of GDP).

“Our forecast for a gradual path of deficit reduction reflects the rising cost of debt service and a significant increase in government spending on defence and climate change”.

Moderate fiscal deficits and tepid economic growth will lead to a stabilisation of general government debt at around 67% of GDP in the medium term, 8pp of GDP higher than the pre-pandemic level at 58.8% of GDP.

This compares favourably with the Eurozone average at around 106% of GDP, but it is significantly above the ‘AAA’ median at 40% of GDP.

From 2024 onwards, government debt should enter a gradual downward trajectory, with the debt/GDP ratio falling to 66% by 2026. Debt could fall faster if cash reserves accumulated during the pandemic are run down.

Germany’s bond yields have increased substantially since the start of the monetary tightening cycle, to 2.2% at the end of March from only 0.2% in February 2022.

The long maturity of Germany’s debt at 7.6 years means that the pass-through of the higher financing cost will be gradual.

“Notwithstanding the long average of debt, we estimate that around 23% of total debt will mature in less than one year, the highest share of debt among the EU countries.

“We expect the interest payments/revenue ratio to increase to 1.4% in 2024 from 0.9% in 2022, above the ‘AAA’ median of 0.9%”.

The German banking sector’s ‘a’ Banking System indicator reflects resilient asset quality and sound capitalisation and funding and liquidity. This should limit the impact on German banks’ credit profiles from the energy crisis and economic slowdown.

The latter is likely to dampen business conditions for banks, as reflected in Fitch’s deteriorating 2023 sector outlook. Fitch expects lower lending volumes and increasing loan impairment charges, resulting in overall lower sector profitability.

German banks’ funding profiles benefit from a deep deposit base, which is the largest in Europe with about EUR4.6 trillion in total deposits and a sector loan-to-deposit ratio below 100%. A large portion of deposits is sticky retail deposits, which should also mitigate the impact of rising interest rates.

Risks stemming from the real estate market are mitigated by the very high share of mortgage contracts on fixed interest rates (typically for 10 years) and sound, affordability-focused underwriting standards.

Fitch expects house prices to decline only slightly over the next 24 months, following a decade of sustained, robust price growth, which is also limiting banks’ potential losses.

According to the Bundesbank’s analysis, in a scenario where house prices fall by 30% and unemployment rises to 10%, banks’ losses would amount to 0.7% of the affected loan volume.