Some organisations are projecting growth rates of over 2% for Germany. Whilst we also expect the German economy to outperform the euro zone average for the time being, we are more sceptical about expected growth; the tailwind from the Emerging Markets is much weaker than in recent years and investment is being constrained by low profit margins. Consequently, the Ifo business climate probably has only limited upside potential.
What is more, there is an increasing likelihood that the ECB’s hopes of a significant euro zone economic upswing will be disappointed. Déjà vu? Given the weaker euro and cheap oil, many forecasts for German economic growth this year have been lifted above 2%. The picture was similar in spring 2014, when consensus expected a 2% growth rate for last year.
The euphoria did not last long though: only a few months later, the plunge in sentiment indicators and weaker hard data prompted many to view Germany as being on the verge of recession. Inflated expectations could be disappointed this year too; only private consumption continues to bring good news, as it benefits from a robust labour market and the recent slide in energy prices. Exports and investment on the other hand are not showing such a rosy picture. Barely any tailwind from emerging markets As in spring 2014, there are increasing signs of relatively weak EM demand.
Real imports across the EM space in January were 2% lower than in January 2014 (chart on front page) and the Q1 figures available for China’s (nominal) imports (-17.6% year-on-year) argue against the view that this was a one-off decline. The latest figures reinforce the impression that the boom times are over for Emerging Markets. While they are still growing faster on average than the industrial countries, their growth advantage has narrowed considerably (Chart 1), as several factors that had fuelled growth over and above that resulting from the catch-up process have now vanished:
• Private sector debt: Over the course of many years private households and businesses in the emerging markets significantly increased their debt in order to fund additional consumption and investment (Chart 2). In China, the private-sector debt-to-GDP ratio has surged by 50 percentage points since 2008 to 180% while in Brazil, it has almost doubled in this period, albeit from a lower level.1 Given the high level of debt that has meanwhile been accumulated, the process of debt increases has now slowed and the impetus this gives to the economy has weakened as well.
• Commodity prices: Many emerging markets such as Brazil and Russia have profited from the commodities boom and the resulting sharp rise in prices. This is no longer the case. In particular, those countries that have concentrated on energy exports, such as Russia, now face strong headwinds on this front.
As these impulses disappear, the structural problems in many of these countries – such as a lack of legal security, inefficient administration or deficient infrastructure – are coming to the fore. Since it will take some time to correct high debt levels and a renewed commodities boom is not on the horizon, EM demand for German products should rise at a much slower rate than in past years. Without the booming EM business – its share of German exports has increased since the start of the new millennium by over ten percentage points to 40% (Chart 3) – the German economy would not have been able to expand as strongly as it has done.
This stimulus will obviously fade and will not be replaced by stronger growth in the advanced economies. Consequently, despite the weaker euro, German exports will rise at much lower rates than in the years when the German economy was expanding at rates in excess of 2%. Lower earnings margins are dampening investment … Investment could prove a further weak point as investment in machinery and equipment has been stagnating since spring 2014, despite extremely favourable financing conditions and increasing capital utilization in manufacturing.
Furthermore, weak domestic orders for industrial goods of late give little hope of a significant revival any time soon. One major reason for this is likely to be the fact that corporate profit margins are coming under increasing pressure from stronger pay growth. In two of the past three years, unit labour costs in Germany have risen at a sharper rate than the GDP deflator (an indicator for companies’ selling prices). While selling prices should rise at a slightly stronger pace this year on account of the weaker euro, this will barely be enough to compensate for the effect of the introduction of the minimum wage on unit labour costs. Consequently, our profit margin indicator, corresponding to the difference of the rate of change of these two parameters, will likely decline again (Chart 4).
There can therefore be no talk of profit margins in line with those which accompanied the investment boom in the middle of the last decade; nor is a technology surge like at the end of the 1990s in sight either. … and therefore consumption in the medium term With a share of just under 6½%, the direct influence of investment in machinery and equipment on GDP is of course limited. That said, it does largely determine the direction of the labour market. The year-on-year rates of real capital investment and the working hours of employees have shown a very close correlation over the past few years (Chart 5). Without a strong renewed acceleration in investment, job growth is also likely to lose momentum. Private consumption would then also grow at a slower pace than recently over the remainder of the year, especially as the impetus from lower energy prices is set to diminish
