Germany: The Ebb and Flow of an Economic Powerhouse I - Why Investors are Adopting such a Gloomy Perspective on Germany’s Economic Future

The Frankfurt skyline (Photo: Thomas Wolf, Creative Commons Attribution-Share Alike 3.0, via Wikimedia Commons)

The past two and a half years have represented a tumultuous period for Europe’s economic powerhouse, which began with the outbreak of the COVID-19 pandemic. With countries halting economic activity and imposing restrictions to quell the spread of the virus, many German companies were hit hard as their revenues collapsed before them. Just as markets were rebounding off the back of a successful vaccination programme, Germany received another shock owing to Russia’s invasion of Ukraine in February 2022. With the West waging economic warfare on Russia, which has weaponised energy supplies in retaliation, Germany is on the brink of a financial crisis. How are German businesses coping in such turbulent conditions? What other issues might they have to contend with? All this, and more, shall be explored in my column.

“Die Lage ist für viele Unternehmen schon jetzt oder in Kürze toxisch” (The situation for many companies is, or soon will be, toxic). This warning in July by Siegfried Russwurm, president of the Bundesverband der Deutschen Industrie, seems to epitomise the growing sense of dread with which investors are watching Europe’s largest economy as it heads into the winter months. According to the ZEW Institute’s Stimmungsindikator, which measures the sentiment towards the German market in each quarter, investors are as concerned now as they were at the time of the 2008 financial crisis, emphasising the grave situation that many predict is looming on Germany’s horizon. This begs the question: what is at the root of all the pessimism? The answer, unsurprisingly, comprises a range of factors, rather than some monocausal explanation. 

On 24 February 2022, global markets were shaken by the news that Russia had initiated a full-scale invasion of Ukraine, signalling war had broken out in Europe. As the EU decried the brutal attack on Ukrainian sovereignty, the bloc issued a barrage of sanctions against the Kremlin in an attempt to isolate its economy, such as agreeing to reduce Russian gas imports by two thirds within a year. Whilst necessary politically, such measures have been extremely costly for Germany, owing to its reliance on Russian gas. Germany imports roughly 60% of its total energy use, and at the time of the invasion, around 50% of the country's gas imports came from Russia. Knowing this, the Kremlin retaliated by steadily reducing the flow of gas to Germany via the Nord Stream 1 pipeline that supplies much of Europe, before turning the tap off altogether in September. 

As a result, there has been a spike in wholesale gas prices, leaving many German companies and households fearful for their financial security as energy bills soar. While German Chancellor Olaf Scholz has been searching for ways to replace this harsh drop in supply, striking an agreement under which the UAE shall provide liquid natural gas later this year, economists have warned that a particularly cold winter could bring about perilous economic conditions in Germany. Energy prices have already forced numerous manufacturers to scale down production, and in the emergency that gas rationing is required, top economic institutes forecast that the German economy could shrink by 7.9% next year.

For Germany’s largest utility company, the damage inflicted by the energy crisis has almost been fatal. As Europe’s biggest importer of Russian gas, Uniper was hit hardest by the cessation of supplies, as its only option was to turn to the spot market at a far greater expense in order to fulfil its contractual obligations. This pushed Uniper to the brink of collapse, before the German government stepped in and nationalised the company, with the total cost of the bailout amounting to €29bn. Uniper might not be the last German gas supplier which Deutschland AG is forced to acquire, with VNG also pleading for further support from Berlin. The symbolic significance of one of Europe’s largest companies narrowly avoiding insolvency underlines the concerns of many investors, who are liquidating positions in German businesses that could be next to fall. 

On top of this, Germany must contend with the highest level of inflation it has faced in 70 years. While this is, of course, linked in part to the surge in energy prices, the effects have been felt across various sectors, with German food prices increasing by 18.7% in the year to September. Consequently, investors expect consumer spending to fall as households see their disposable income slashed, which is particularly alarming for retailers such as Douglas. Specialising in beauty products, the Düsseldorf-based company could see its sales plummet, which would cause difficulties in servicing the €475mn of debt it has outstanding. More generally, the record levels of inflation have stoked fears of ‘stagflation’, in which Germany’s economic growth is stunted whilst inflation accelerates, representing an inhospitable environment for business. 

In a bid to alleviate Europe’s inflationary pressures, the European Central Bank (ECB) raised interest rates by 75 basis points in September, taking the benchmark deposit rate to its highest point since 2011. This increases the cost of borrowing, and with less cash flowing through the economy as a result, this should help to temper inflation. However, as prices continue to rise, there have been calls for the ECB to triple the current rate by the end of the year, which would come as a shock to those requiring fresh capital. For example, German companies in the construction sector would face serious adverse effects; not only do rate hikes make projects more expensive, but the increased cost of mortgages means there is less demand for housing from potential homeowners. In fact, the cracks are already beginning to show, with the Statistisches Bundesamt calculating that the number of building permits in the first seven months of 2022 decreased by 2.1% compared to the same period last year.

To support businesses and consumers, the German government plans to introduce a cap on energy prices via a €200bn package, to be funded by new borrowing. The so-called Abwehrschirm (defensive shield) shall thus provide German companies with subsidies and make them more competitive, although this has been criticised by other EU member states who must bear the brunt of the crisis. Additionally, in a stunning revival of Europe’s IPO market which had lain dormant for much of the year, Porsche’s listing on the Frankfurt Stock Exchange in late September was met with strong enthusiasm, with shares in the sports car group selling at the top of their price range. 

So, with that in mind, it might not all be doom and gloom for the German economy. Nevertheless, investors will be anxiously surveying the situation as business owners brace themselves for surging energy costs, spiralling inflation and a hawkish ECB. On a final note, the irony that I have named this column ‘The Ebb and Flow of an Economic Powerhouse’ is not lost on me. Yet the question remains - how long can Germany’s status as Europe’s leading financial force survive?