Article from Stratfor.com
Today's Featured Analysis
Germany: Ratings Threats and New Challenges
Summary
Credit ratings agencies have put Berlin on notice that Germany's
AAA rating might be endangered if the country's economic house
isn't put into order. Germany's debt problems are about to
worsen, even without a credit downgrade, as the euro matures and
the European Union expands.
Analysis
Standard & Poor's and Fitch Ratings, two of the world's largest
credit risk ratings firms, have served notice to Germany that it
could lose its premium AAA debt rating if it cannot get deficit
spending under control. A lower credit rating would make it more
expensive for Germany to finance its debt.
Though the country's debt problems have hardly reached the
Godzilla proportions of Japan's, the situation has deteriorated
sharply in the past two years. Part of the criteria for joining
the eurozone was that no euro country could run a deficit in
excess of 3 percent of GDP. The 2000 energy shock, 2001 global
recession, post-Sept. 11 fallout and Iraq-related war jitters
combined to drive German growth through the floor and debt
through the roof. Germany's budget deficit is now 3.4 percent of
GDP, unemployment stands at 11 percent and GDP is stagnant, with
no signs that the situation will rectify itself anytime soon.
Stratfor doesn't actually expect a credit downgrade this year --
Germany is simply too big to fall quickly, and its current rating
outlook is neutral, not negative. But Berlin is doing very little
to avoid a drop in overall economic performance. Chancellor
Gerhard Schroeder has proposed some modest reforms that are
indeed a step -- if a timid one -- in the right direction, but
the only real passion in the political system comes from the
legislators and ministers who would like to see a German
counterweight to the American credit ratings firms. Economics
work differently in Europe, you see.
But Berlin's problem is more complicated than simply a matter of
bad domestic policies. The international climate in which the
country is competing for investors' cash also has become more
difficult. Though Germany has rarely had problems recruiting
buyers for its debt, several European states that used to be in
different risk baskets have seen their credit ratings rise in
recent years, partly via their association with Germany and
France via the euro.
Though this is broadly beneficial to Europe as a whole -- easier
credit terms, better liquidity and more wealth and economic
activity -- it also has placed most of the debt issued by the
other European governments in the same risk basket as German
debt. The sheer size of the German economy, some $1.9 trillion,
has allowed the country's debt to remain in fashion, but since
the euro's adoption Germany has gone from one of five states with
a premium debt rating to one of seven, with five others rapidly
closing the gap. The result is pressure on German debt sales just
as the country's economic performance -- and the all-important
credit rating -- is being called into question.
That competition for a finite number of debt-financing euros is
about to intensify. In June 2004, 10 new states will join the EU,
and all will likely be rewarded with immediate credit ratings
increases -- based both on their own merits and their closer
association with Europe. That means that Germany is about to
become one in 22. As with the formation of the eurozone, this
evolution was by design. One of the EU's primary tenets is to
promote economic convergence of its members. But what was not
anticipated was that by making things easier for the Union's
poorer members, things would necessarily get more difficult for
Germany.
This will make the chancellor's job more difficult in the coming
18 months. The Iraq war has Berlin in the "extraordinary
circumstances" it needs to temporarily get away with its deficit
spending. The brevity of the war, however, means that this window
is narrow and closing. The pressures of the Stability Pact (which
was, incidentally, written by Germans) will return shortly.
With them will come all the normal issues associated with high
deficits. Chronically high deficit spending tends to drive up
interest rates as the government competes with private businesses
for available capital. It also tends to gobble up resources,
spiking the inflation that has been the avoid-at-all-costs
bugaboo of European policymakers for decades. Throw in a gaggle
of new Central European EU members, whose presence in the club
will make financing German debt more costly, and Germany could
well become a state locked into a cycle of high debt and low
growth.
The bottom line is that even without another credit downgrade,
the cost of financing Germany's debt is about to rise. That will
make it more difficult for Schroeder -- or in Stratfor's view,
whoever replaces him -- to use government spending to jumpstart
the nation's economy. Just as the rest of Europe has benefited
from association with Germany, the state's continued inability to
get its economy growing now acts as an anchor weighing down
growth on the continent as a whole.
So far, Europe has avoided the worst. France and Italy, while not
exactly dynamic, have generated enough growth to keep the EU
lurching forward, but this state of affairs cannot last. Unlike
defunct Japan, which depends upon the rest of the world for about
one-fifth of its economy, nearly three-fifths of German GDP --
some $1 trillion -- revolves around international trade. About
half of that is with the current EU-15. Germany's situation might
not yet be as intractable as Japan's, but a Japanese-style
shriveling in Germany would hurt Europe far more than Japan's
narcosis has harmed Asia. |
