Good Prospects in Germany

Crédito y Caución estimates that corporate insolvencies will decrease by 5% year-on-year - to 30,000 cases - in 2011, provided that some downside risks will not materialise.
Analisis Credito y Caución
Madrid - 07-jul-2011

Germanys surprisingly good economic performance in 2010 manifested itself in fewer business failures. According to the German Statistics Office, the number of corporate insolvencies decreased 2.1% year-on-year - to 31,998 cases - after an 11.6% increase in 2009, and in January this year they dropped by as much as 9.5% year-on-year. For the whole of 2011, we expect another 5% decrease provided that potential downside risks such as much higher interest rates, further escalation of the Euro debt crisis and a severe deterioration of the political situation in Northern Africa and the Middle East, leading to sharply increasing oil prices/disruption of supplies, do not materialise. However, even if the economic environment remains benign, we still expect higher than average risks for sectors such as construction, shipbuilding, printing, and textile.

February 2011´s median Expected Default Frequency [EDF] for Germany continued its moderating trend of recent months, albeit at a slower rate: dropping 1 basis point on the previous month, to 31 basis points. This trend has seen a 36 basis points reduction since the start of 2010, with the EDF now standing at its lowest level since June 2008, i.e. before the credit crisis began. This improvement is due mainly to a rise in equity prices and a simultaneous reduction in market volatility.

The Expected Default Frequency is based on listed companies in the markets referred to, and the likelihood of default across all sectors within the next year. In this context, default is defined as a failure to make a scheduled payment, or the initiation of bankruptcy proceedings. Probability of default is calculated from three factors: market value of a companys assets, its volatility and its current capital structure. As a guide, the probability of one firm in a hundred defaulting on payment is shown as 1%.

In the last quarter of 2010, Germanys rebound slowed down slightly, with 0.4% real GDP growth on the previous quarte. Growth in the last quarter of 2010 was driven mainly by exports, which increased 2.5% on the previous quarter [compared to a rise of just 0.9% in imports], rising investments and domestic consumption, all of which compensated for the drop in construction investments [down 3.9%] caused by adverse weather conditions. Overall GDP grew 3.6% year-on-year in 2010: well above the Eurozone average. The International Monetary Fund expects Germany to grow 2.5% in 2011, while the German government expects 2.6% and some leading German economic institutes even forecast a growth rate of 2.8%.

On an annual basis, the value of commodities exports and imports increased 18.5% and 20.0% respectively in 2010, and the trade balance surplus rose to Euro 154.3 billion. While Germanys exports to EU neighbours rose 15.5%, those to the US increased by 20.6% and to China by a massive 43.9%: more than to any other destination. Germany has profited hugely from the surging demand from China and other emerging markets for its specialised goods: industrial machinery, cars, electronics and consumer goods. This export boom has benefited those sectors that had suffered an immense slump during the crisis, such as automotive and metals. German car exports rose 25% year-on-year in 2010, and by a further 11% in Q1 of 2011.

The export boom has continued into 2011, with a 24.2% increase in January and 21% in February, according to the German Statistical Office. However, imports rose even faster than exports in January and February [up 27%], resulting in a lower trade surplus and indicating that the current boom is becoming more balanced, with domestic demand, rather than the mainly export-driven growth of recent months, contributing more to future growth.

Private consumption, previously weak, rebounded during 2010, with positive year-on-year growth in Q3 and Q4 [1.1% and 1.4% respectively] and 0.5% and 0.2% on the previous quarters. Overall, private consumption increased 0.4% last year, contributing positively to GDP growth, and the German government expects an increase of 1.3% this year. After a 3.1% decrease in 2009, retail turnover increased 1.2% year-on-year in real terms in 2010. This continued in January and February 2011, with a 1.8% year-on-year increase.

The recent marginal drop in German consumer confidence can be attributed partly to developments in Northern Africa and the Middle East, and to rising energy prices. Consumer prices have increased steadily in the last few months and rose 2.1% year-on-year in March 2011 [0.5% higher than in February 2011 and the highest consumer price inflation since October 2008]. The main drivers were energy costs [oil, fuel and electricity], which increased 10.5% year-on-year. For the whole of 2011 inflation is expected to increase to 2.4%. This persistent rise in inflation could potentially act as a brake on the increase in private consumption, especially if oil prices increase sharply in the coming months. The European Central Bank raised interest rates in early April to counter inflationary pressures in the Eurozone.

According to the Bundesbank and the German Ministry of Economics and Technology, industrial production increased 11.6% year-on-year in 2010, while new orders rose 21.7% [16.3% domestic and 26.5% from abroad]. This boom has continued into 2011, with a 1.6% production increase on the previous two months across all manufacturing sectors in January and February, while orders rose 2.4% [18.3% year-on-year]. This means that industrial output is back to pre-crisis levels.

Construction output increased 0.2% in 2010 and, after a slump due to adverse weather conditions in December, rose by 18.5% on the previous two months in January and February 2011. After a 1.1% increase in 2010, new building orders surged 8.6% year-on-year in January this year. Residential and business construction contributed positively last year, and the sector expects rising orders and turnover in 2011.

This rebound is reflected in rising investments. According to the Federal Statistical Office, capital formation in machinery and equipment increased 10.9% in 2010, thus contributing very strongly to last years economic growth. In the last quarter of 2010, capital investment rose 17.6% year-on-year and 2.6% on the previous quarter. This positive trend is expected to continue in 2011 thanks to the benign outlook for German industry production and orders. The same goes for construction investment, which grew 2.8% last year.

Due to robust export performance and increasing domestic demand, major German sectors such as automotive, mechanical engineering, steel chemicals, and electronics have all recently revised their production forecasts upwards. However, some downside risks persist, such as the possibility of severe disruption to supply lines, due to the devastation in Japan, which would hit the automotive and electronics sectors, and sharply rising oil prices, which would have an immediate impact on the chemicals, automotive and construction sectors.

As a consequence of the credit crisis and stimulus measures, government debt increased sharply to 73.5% of GDP in 2009 and rose further in 2010. However, after a budget deficit increase to 3.3% of GDP in 2010 [see chart below], the Federal Government aims to reduce the deficit to 2.5% of GDP this year, thanks to the improved economic performance [with higher tax revenues and lower government transfer payments for unemployment and short-time working benefits].

Germany passed a debt brake law in 2009, forcing the government to cut spending. After a transitional period, the law sets a limit for structural new debt at 0.35% of GDP by 2016 after which it must remain at that level, with additional borrowing possible only if the economy is weak.

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