For the detailed rating report, click here.

Scope Ratings GmbH has today affirmed Germany’s AAA long-term issuer and senior unsecured local- and foreign-currency ratings, along with a short-term issuer rating of S-1+ in both local and foreign currency. All Outlooks are Stable.

Rating drivers

Scope’s affirmation of the AAA rating of the Federal Republic of Germany reflects the country’s large and diversified economy, solid fiscal framework, and high external competitiveness. The rating is challenged by future pension liabilities, low domestic investment, and adverse demographics.

Germany has experienced strong growth since the Great Financial Crisis, averaging 2.2% between 2010-2017. The economy is close to full employment, with the unemployment rate at a new record-low of 3.8% in 2017, robust domestic demand and high net exports. Growth is set to remain strong in 2018 and ease only slightly in 2019, with growth of 1.9% and 1.8% respectively. The strong and lasting recovery after the financial crisis has been driven by the country’s exceptionally competitive industry and the European Central Bank’s (ECB) ongoing accommodative monetary stance. The country’s GDP per capita has increased by 11% since 2010, more than twice the increase achieved by other large euro-area countries including France, Italy and Spain.

The AAA rating is further underpinned by Germany’s fiscal policy framework, which is designed to supress budgetary risks. The country’s discipline constitutionally enshrined in 2009 is clearly defined at both sovereign and sub-sovereign level. The ‘debt brake’ stipulates that the structural federal deficit cannot exceed 0.35% of GDP from 2016 and that the German Länder (federal states) are not allowed to generate any structural deficits from 2020. Moreover, the current and previous government agreed to achieve balanced budgets every year, known as ‘black zero’. Based on its prudent fiscal policies general government debt to GDP has declined by nearly 20 percentage points over the past six years.

Germany’s public finances have been outperforming government targets, underpinned by strong economic growth, benign tax revenue growth, and controlled expenditure restraint. According to the 2019 budgetary draft Germany’s general government fiscal surplus is expected to fall from approximately 1½% of GDP in 2018 to approximately 1% of GDP in 2019. Fiscal policy is expected to turn procyclical between 2019-2022 with the government intending to spend additional funds primarily on consumptive expenditure including social security. In our opinion, the budgetary plan falls short of expectations in view of the country’s elevated investment needs, including digital and transport infrastructure. According to government calculations, tax cuts and social policy expenditures will come to 1.9% of GDP between 2018-2022. At the same time, additional investment in education, research and digital technologies will add 0.4% of GDP to budgetary expenditures. The government recently announced a 0.3% cut in the unemployment insurance contribution for employees which is, however, cancelled out by an equal increase in the healthcare contribution, leaving the country’s tax wedge among the highest in OECD economies.

Since the beginning of the European sovereign debt crisis, Germany has continued to benefit from investors’ flight to quality, resulting in refinancing costs reaching record lows. With ongoing budget surpluses as well as favourable growth and financing prospects, we expect the debt-to-GDP ratio to further decrease to around 56% in 2019, from 63.8% in 2017. With this solid downward trajectory, the ratio could fall below 50% by 2021 (assuming constant primary surpluses and moderate growth). Moreover, Germany benefits from the euro as a reserve currency with its securities being among the most actively traded and most liquid sovereign debt instruments worldwide. Germany’s debt securities have benchmark status in the euro area, reflected by highly favourable financing conditions and further strengthened with the continuous asset purchases of German bonds by the ECB to refinance its portfolio contributing to the current real negative yields on 10-year German bonds.

Germany’s stable AAA rating also benefits from low external risks, given the country’s sound net international investment position. This stood at 54% of GDP at end-2017. The economy’s external strength is primarily driven by its large current account surpluses, averaging 8% of GDP from 2013-2017. Germany’s net creditor position has also been supported by the steady increase in current account surpluses since 2002. The high current account surplus is derived from the country’s strong merchandise balance and growing primary income balance. In 2017, the real effective exchange rate appreciated by 1.4% versus non-euro industrial countries based on higher energy and raw material prices and a nominal appreciation of the euro against the US dollar. This loss was compensated for by a continuous increase in competitiveness versus euro area trading partners. Going forward, Scope expects that the fundamental strength of German exporters outweighs potential risks from increasing global protectionism.

Despite the relative strengths of Germany’s rating, challenges remain. The country’s faces a low potential growth rate, which will be negatively affected by a labour shortage resulting from population ageing with many of the baby-boomer generation leaving the workforce. The unfavourable demographics, weak investment, declining entrepreneurship, and limited progress on digital transformation restrict the country’s productive capacity, which is unlikely to be widened without major reforms to the supply side. The country’s growth potential is estimated to be around 1.3%, which is one of the lowest in the euro area.

In addition, Germany’s demographic change is likely to increase age-related spending and dampen government revenue generation on the back of weaker economic growth. To help mitigate this, further adjustments to the social security and pension systems are needed. Even so, we believe the government will face challenges in addressing these issues, including achieving a consensus with the ageing electorate when it comes to reforms. If no action is taken, the debt ratio, including future liabilities from health and pension expenditure will bring Germany back into the realm of highly indebted countries in the euro area.
The profitability of German banks continues to be weak compared to peers. Record-low interest rates, intense competition, crisis legacy issues, and a high cost base contribute to weak profits. Margins have gradually eroded, especially in smaller retail banks which mainly depend on mortgage financing. For the most exposed banks, regular stress tests and simulations by supervisors have also led to additional capital requirements. The low share of non-performing loans partially obscures large German banks’ lack of a sustainable business model. The institutions are also facing higher regulatory compliance costs caused by new regulations (Solvency II and MifiD II) which may further impair their profitability.

Recent regional elections in Bavaria and Hesse have created further headwinds for the coalition government. Given that the next regular elections are scheduled for autumn 2021, we expect the current coalition to remain inherently unstable in view of forthcoming elections to the European Parliament in May 2019 and continuously fading public support. However, Angela Merkel’s announced step-down from the CDU has limited implications since she will stay on as Chancellor for now. While a split of the current coalition could trigger early elections, this is unlikely as the three parties would risk losing seats in the Bundestag. 

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides an indicative ‘AAA’ (‘aaa’) rating range for Germany. Scope affirms the indicative rating of ‘aaa’ for Germany. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis.
For Germany, the following relative credit strength has been identified: i) fiscal policy framework; ii) market access and funding sources; iii) current account vulnerability; iv) external debt sustainability. Relative credit weaknesses are: i) growth potential of the economy; ii) recent events and policy decisions; iii) banking sector performance. The combined relative credit strengths and weaknesses indicate a sovereign rating of AAA for the Federal Republic of Germany. A rating committee has discussed and confirmed these results.
For further details, please see Appendix II of the rating report.

Factoring of Environment, Social and Governance (ESG)

Scope considers ESG sustainability issues during the rating process as reflected in its sovereign methodology. Governance-related factors are explicitly captured in Scope’s assessment of ‘Institutional and Political Risk’, for which Germany scores high according to the World Bank’s Worldwide Governance Indicators. Qualitative governance-related assessments in Scope’s ‘geo-political risk’ category of its QS are assessed as ‘neutral’ compared with Germany’s sovereign peers. Socially related factors are captured in Scope’s CVS in Germany’s high GDP per capita (USD 44,769 in 2017) and record-low level of unemployment but increasing old-age dependency ratio. Qualitative assessments of social factors are reflected in Scope’s ‘macroeconomic stability and sustainability’, for which Scope assesses Germany as ‘neutral’. Finally, environmental factors are considered during the rating process but did not have an impact on this rating action.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s assessment that the risks faced by Germany remain balanced at this stage. The rating could be downgraded if: i) public finances deteriorate strongly due to a reversal of fiscal consolidation; ii) there is a reversal of structural reforms; and/or iii) a strong deterioration of sovereign risk in the euro area, which could affect Germany’s creditworthiness.

Rating committee

The main points discussed were: i) the fiscal budgetary programme, ii) growth potential, iii) pension liabilities, iv) external debt sustainability, v) international competitiveness, vi) housing market developments, vii) political developments and viii) peer comparisons.

Methodology
The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on www.scoperatings.com. Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com. The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rating was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the rating process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party. The following substantially material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: German Bundesbank, German Ministry of Finance, Federal Statistical Office, Eurostat, European Central Bank, IMF, World Bank.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Rating prepared by Dr Bernhard Bartels, Lead Analyst
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director
The ratings/outlook were first released by Scope on 30 June 2017.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
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