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November 5, 2014
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We have cut our German GDP growth forecast from 1.5% to 1.3% for 2014 and further from 1.5% to 0.8% for 2015. We do not see Germany falling into a technical recession in Q3. But the 6 month slump of the ifo index has increased the risk that we might see a negative GDP print in Q4 2014 or Q1 2015. The positive effect of weaker oil prices will be offset by wage growth slowing from 3% plus this year towards 2% in 2015, as export-orientated sectors will respond to weaker external demand. Further topics in this issue: German industry: Temporary slowdown; German construction: Robust investment, but price momentum slowing; Inheritance tax: Constitutional Court ruling likely to weigh harder on business heirs; 25 years after the fall of the Berlin Wall: "Blooming landscapes" only in part. [more]
Focus Germany: Further disappointments Current Issues Business cycle German GDP growth: Below 1% in 2015. We have cut our German GDP growth forecast from 1.5% to 1.3% for 2014 and further from 1.5% to 0.8% for 2015. We do not see Germany falling into a technical recession in Q3. But the 6 month slump of the ifo index has increased the risk that we might see a negative GDP print in Q4 2014 or Q1 2015. The positive effect of weaker oil prices will be offset by wage growth slowing from 3% plus this year towards 2% in 2015, as export-orientated sectors will respond to weaker external demand. German industry: Temporary slowdown. Following weak performance in winter half-year 2014/15 industrial production is likely to return to a moderate uptrend in the course of 2015, resulting in expansion of roughly 1.5% in real terms in 2014 and about ¾% in 2015. The only moderate growth of industry is primarily attributable to the currently subdued level of business activity and external shocks. Nonetheless, structural factors are going to regain importance. Many of the recently adopted measures will erode Germany's international competitiveness as an industrial location. German construction: Robust investment, but price momentum slowing. Scarcity of supply is the key attribute of the current German real estate cycle. It seems likely to persist in the years ahead. House prices still have the biggest potential in the real estate market. Completions are on the rise and construction investments should continue to grow strongly in 2014 and 2015. Construction investments should also rise in the public and the commercial sector. Inheritance tax: Constitutional Court ruling likely to weigh harder on business heirs. The Court’s ruling could lead to more restrictive regulations on business assets in cases of inheritance and gift-based transfers. The tax burden on business heirs and Germany's small and medium-sized enterprises (the Mittelstand) could increase. The potential burden hinges partly on what tax volume the government would like to generate. 25 years after the fall of the Berlin Wall: "Blooming landscapes" only in part. After the initial massive catch-up process, the real economic convergence of the east German economy has been stalling since the mid-2000s. In view of the continuing massive support of the east German Laender (federal states), the stalling convergence suggests continuing structural differences between the old and the new Laender. Author s Eric Heymann +49 69 910-31730 eric.heymann@db.com Jochen Möbert +49 69 910-31727 jochen.moebert@db.com Heiko Peters +49 69 910-21548 heiko.peters@db.com Oliver Rakau +49 69 910-31875 oliver.rakau@db.com Stefan Schneider +49 69 910-31790 stefan-b.schneider@db.com Frank Zipfel +49 69 910-31890 frank.zipfel@db.com Editor Stefan Schneider Deutsche Bank AG Deutsche Bank Research Frankfurt am Main Germany E-mail: marketing.dbr@db.com Fax: +49 69 910-31877 www.dbresearch.c om DB Research Management Ralf Hoffmann Content Page Forecast tables ...............................................2 German GDP growth: Below 1% in 2015 ........3 German industry: Temporary slowdown ..........5 German construction: Robust investment, but price momentum slowing ..........................8 Inheritance tax: Constitutional Court ruling likely to weigh harder on business heirs ........ 15 25 years after the fall of the Berlin Wall: "Blooming landscapes" only in part ............... 20 Chart of the month ........................................ 25 DB German Macro Surprise Index ................ 26 Chartbook ..................................................... 27 Event calendar .............................................. 34 Data calendar ............................................... 35 Financial forecasts ........................................ 35 Data monitor ................................................. 36 November 5, 2014 Focus Germany Further disappointments Focus Germany 2 | November 5, 2014 Current Issues Economic forecasts DX Real GDP Consumer Prices* Current A ccount Fiscal Balance (% growth) (% growth) (% of GDP) (% of GDP) 2014F 2015F 2016F 2014F 2015F 2016F 2014F 2015F 2016F 2014F 2015F 2016F Euroland 0.7 1.0 1.4 0.5 1.1 1.5 2.5 2.1 1.6 - 2.6 - 2.5 - 2.1 Germany 1.3 0.8 1.2 1.0 1.2 1.5 7.2 6.4 6.2 0.0 - 0.5 - 0.8 France 0.4 0.9 1.5 0.6 0.9 1.5 - 1.8 - 1.8 - 1.5 - 4.4 - 4.3 - 3.8 Italy - 0.4 0.4 0.7 0.2 0.8 1.2 1.6 1.6 1.5 - 3.0 - 2.9 - 2.7 Spain 1.2 1.9 1.8 - 0.1 0.8 1.4 0.4 0.5 0.7 - 5.6 - 4.6 - 3.3 Netherlands 0.7 1.7 1.1 0.5 1.1 1.5 10.9 11.4 11.5 - 2.5 - 2.0 - 1.9 Belgium 1.0 1.0 1.6 0.7 1.3 1.5 - 1.0 - 0.8 - 0.5 - 2.5 - 2.3 - 2.2 Austria 0.8 1.3 1.8 1.5 1.7 1.7 2.7 2.9 3.1 - 3.0 - 1.8 - 1.2 Finland - 0.4 0.6 1.6 1.1 1.2 1.4 - 2.0 - 1.7 - 1.3 - 2.4 - 1.8 - 1.1 Greece - 0.2 2.1 2.7 - 1.0 0.4 0.9 1. 0 1.5 1.5 - 1.8 - 0.6 0.1 Portugal 1.0 1.1 1.7 - 0.1 0.9 1.3 1.0 1.0 1.0 - 4.2 - 3.3 - 2.7 Ireland 3.7 2.5 3.7 0.4 1.1 1.6 6.5 7.0 7.0 - 4.0 - 2.7 - 2.5 UK 3.1 2.5 2.3 1.7 1.9 2.0 - 4.0 - 3.2 - 3.0 - 4.6 - 3.5 - 2.1 Denmark 1.0 2.0 1.8 1.0 1.5 2.0 6.7 6.4 6.0 0.0 - 1.0 - 2.0 Norway 2.4 2.5 2.5 1.8 2.2 2.0 11.0 10.5 10.0 7.0 6.7 6.5 Sweden 2.2 2.6 2.5 0.2 1.5 2.0 6.0 5.5 5.0 - 1.5 - 1.0 - 0.5 Switzerland 1.3 1.8 2.0 0.0 0.3 0.6 12.0 11.0 10.5 0.0 0.2 0.5 Czech Republic 2.4 2.6 2.8 0.4 1.8 2.0 - 1. 5 - 1.4 - 1.5 - 2.6 - 2.5 - 2.4 Hungary 3.4 2.7 3.0 0.2 2.6 3.3 1.6 1.5 1.5 - 2.9 - 2.7 - 2.8 Poland 3.1 3.5 3.8 0.2 1.1 2.3 - 1.8 - 2.0 - 2.2 4.3 - 2.9 - 2.8 United States 2.3 3.5 3.1 1.8 2.2 2.4 - 2.5 - 2.5 - 2.6 - 2.9 - 2.5 - 2.8 Japan 1.0 1.3 1.4 2.9 1.7 1 .8 0.2 1.4 2.1 - 7.0 - 6.1 - 4.6 China 7.3 7.0 6.8 2.2 2.6 3.0 3.1 3.4 3.3 - 2.1 - 2.5 - 3.0 World 3.2 3.7 3.8 3.5 3.7 3.7 *Consumer price data for European countries based on harmonized price indices except for Germany. This can lead to discr epancies compared to other DB publications. Sources: National Authorities, Deutsche Bank Forecasts: German GDP growth by components, % qoq, annual data % yoy DX 2013 2014 2012 2013 2014F 2015F 2016F Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Real GDP 0.4 0.1 1.3 0.8 1.2 - 0.4 0.8 0.3 0.4 0.7 - 0.2 0.1 0.0 Private consumption 0.7 0.8 0.9 1.1 1.0 0.2 0.6 0 .7 - 0.8 0.8 0.1 0.3 0.3 Gov't expenditure 1.2 0.7 0.8 0.6 0.3 0.0 0.0 0.6 - 0.1 0.4 0.1 0.2 0.2 Fixed investment - 0.7 - 0.7 3.1 1.7 2.3 - 2.5 2.2 0.8 1.1 2.9 - 2.3 0.0 0.3 Investment in M&E - 2.9 - 2.7 3.4 1.4 4.0 - 3.7 2.3 - 0.5 2.1 2.1 - 0.4 0.0 - 1.0 Construction 0.6 - 0.1 3.2 2.4 2.3 - 2.8 3.0 1.8 0.7 4.1 - 4.2 - 0.1 1.0 Inventories, pp - 1.4 0.2 0.3 0.1 - 0.2 0.2 - 0.1 0.0 0.2 - 0.2 0.4 0.1 0.0 Exports 2.8 1.6 3.1 3.9 5.2 0.7 1.4 0.7 1.7 0.0 0.9 0.5 0.5 Imports 0.0 3.1 4.3 5 .3 5.4 1.2 1.3 1.7 0.7 0.5 1.6 1.0 1.2 Net exports, pp 1.3 - 0.5 - 0.2 - 0.3 0.2 - 0.2 0.2 - 0.4 0.5 - 0.2 - 0.2 - 0.2 - 0.3 Consumer prices* 2.0 1.5 1.0 1.2 1.5 1.5 1.5 1.6 1.3 1.2 1.1 0.8 0.8 Unemployment rate, % 6.8 6.9 6.7 6.8 7. 1 6.9 6.9 6.8 6.9 6.8 6.7 6.7 6.7 Industrial production - 0.4 0.1 1.8 1.0 0.0 Budget balance, % GDP 0.1 0.0 0.0 - 0.5 - 0.8 Public debt, % GDP 81.0 78.4 74.2 72.6 71.0 Balance on current account, % GDP 7.1 6.8 7.2 6.4 6 .2 Balance on current account, EUR bn 196 192 207 190 189 *Inflation data for Germany based on national definition. This can lead to discrepancies to other DB publications. Sources: Federal Statistical Office, Ger man Bundesbank, Federal Employment Agency, Deutsche Bank Research Focus Germany 3 | November 5, 2014 Current Issues German GDP growth: Below 1% in 2015 — We have cut our German GDP growth forecast from 1.5% to 1.3% for 2014 and further from 1.5% to 0.8% for 2015, due to the weaker international environment. — We do not see Germany falling into a technical recession in Q3. But the 6 month slump of the ifo index has increased the risk that we might see a negative GDP print in Q4 2014 or Q1 2015. — The positive effect of weaker oil-prices will be offset by wage growth slowing from 3% plus this year towards 2% in 2015, as export-orientated sectors will respond to weaker external demand. Robust private consumption to facilitate (minimal) GDP growth in Q3 Well, we continue to predict that Germany will not fall into a technical recession as Q3 GDP should still muster a rise, after the 0.2% drop in Q2, but probably by the skin of its teeth. A key factor will be the hoped-for rebound in September IP, following the holiday-distorted 4% slump in August (released on November 7). We expect a substantial recovery as already indicated by the September output data of German car producers. Still, the further deterioration in the confidence data, notwithstanding the modest improvement in the preliminary manufacturing PMI in October, does suggest that the underlying momentum of the economy is weak, despite the robust expansion of private consumption. In addition, the expected technical correction of the negative impact of the seasonal adjustment on Q2 construction spending (worth about ¼ of a percentage point (pp) of GDP) does not seem ready to materialise. Except for building permits all other monthly indicators of construction activity have remained weak in July and August. Therefore, we have lowered our GDP forecast for Q3 to 0.1% (from 0.4%). Beyond Q3 the unabated decline of the ifo index (9 points during the last 6 months) does not bode well. During the last two decades the index only showed such downward momentum between H2 2008 and H1 2009 and in H2 2012, with quarterly GDP moving into the red each time. Unfortunately, there is sufficient evidence to corroborate the gloomy results of such number-crunching exercises. Our Emerging Markets colleagues have revised their forecasts for next year for China, Russia in particular to the downside and have become gloomier regarding Brazil following the elections. The lacklustre performance of the BRIC economies is already quite evident in German exports. While overall nominal exports were still up 2.8% yoy between January and August, deliveries to the 4 BRIC economies (accounting for close to 11 ½% of total goods exports) were down by ½% (although exports to China are still growing at a 10% clip). Despite the Q3 GDP growth of 3.5% which might even be revised higher with the second print, it is questionable whether the US alone can do the heavy lifting for the world economy. Recent disappointing data and renewed political quarrels which are unlikely to dissipate anytime soon suggest that Germany’s European partners will not provide any tailwind. All these issues are evident in the failure of world trade to gain any traction. In the first eight months world exports were flatlining. The year-on-year increase in real world trade stands at 2.6% (Jan/Aug), which is less than the still expected increase in global GDP for the whole year. An underperformance of world trade has in recent decades only coincided with global recessions and is certainly a massive burden for Germany’s export-oriented economy. - 1.0 - 0.5 0.0 0.5 1.0 1.5 2.0 Q2 13 Q3 13 Q4 13 Q1 14 Q2 14 13 14 15 16 Private consumption Public consumption Investment in machinery and equipment Construction investment Inventories Net exports Real GDP Contributions to real GDP growth, qoq, pp Sources: Federal Statistical Office, Deutsche Bank Research Domestic economy the main growth driver 1 60 70 80 90 100 110 120 130 140 150 13 14 Production Official (sa) Production VDA (nsa) Implied official production level in September 2010=100 Source: Federal Statistical Office Auto production: VDA data points to strong increase of "official" auto production in September 2 -5 -3 -1 1 3 5 7 9 -20 -15 -10 -5 0 5 10 15 95 97 99 01 03 05 07 09 11 13 ifo - index (left) GDP (right) Ifo slumps and GDP growth 3 Sources: Thomson Reuters, Deutsche Bank Research 6 month change (left); % qoq (right) Focus Germany 4 | November 5, 2014 Current Issues Tailwind from lower oil prices? One positive development for the German and the world economy as a whole is the mainly supply-driven strong drop in oil prices. Since hitting USD 115.50 in June Brent has dropped to around USD 87/bbl. Even taking the depreciation of the EUR versus the USD into account, which was driven by the anticipated decision of the Fed to end its asset purchases by the end of October and the unexpectedly hawkish tone of the accompanying Fed statement, oil prices are still down by almost 20% versus their June peak and around 15% yoy. We are forecasting oil prices to stay below USD 90/bbl in 2015, which implies a 15% decline versus the 2014 average. This should – ceteris paribus – provide a boost of a good ¼ pp to the global economy, as the savings in the oil-importing countries do have higher demand effects, in particular with regard to private consumption, than the corresponding losses in oil-exporting countries. This demand effect adds about ½ pp to German exports (using standard elasticities, although the discussion above suggests that they might be lower currently). The bigger impact will of course come through the income effect courtesy of the 0.2 pp lower inflation rate. These back-of-the-envelope calculations point to a boost to German GDP through lower oil prices of just under 0.2 pp 1 . Weaker global environment to limit domestic demand growth Unfortunately, the positive effect of lower oil prices on global GDP and German exports, which enjoy an additional boost from the lower EUR (as calculated above), is more than eliminated by the downward revisions to our global GDP forecasts in recent weeks, reaching close to ½ pp – which of course have taken into account or were in fact even triggered (Russia) by our lower oil price forecast. All in all this will shave 1 ¼ pp off German exports, which will translate into weaker investment spending, given the close correlation between these two demand components. But when all is said and done, even the real income effect of the reduced inflation rate might be more than offset by lower wage increases in 2015 than initially thought. Collective wage agreements have been running north of 3% this year. The clear deterioration of the export outlook should push settlements back towards 2% in 2015. Together with a more clouded labour market outlook, not least because of the introduction of the minimum wage, this will make itself felt in real income and hence private consumption. All in all GDP will probably stagnate in the winter half-year. Given the sharp drop in the ifo index in recent months discussed above, we could easily see a negative print in at least one quarter. Even with acceleration towards trend growth in the rest of 2015 this will result in an annual growth rate of 0.8% in 2015 after 1.3% in the current year. Stefan Schneider (+49 69 910-31790, stefan-b.schneider@db.com) 1 Peters, H. (2102). Potential oil price shock boosting downside risks for German economy. Deutsche Bank Research. Current Issues. March 2012. -30 -20 -10 0 10 20 30 08 09 10 11 12 13 14 German exports Global trade Global trade and German exports 4 % yoy (real values) Sources: Deutsche Bundesbank, CPB - 3 - 2 - 1 0 1 2 3 4 5 13 14 GB US CN RU Other Total % yoy (3M mov. avg.) Sources: Federal Statistical Office, Deutsche Bank Demand from GB, US and (still) CN support German exports 5 - 2 - 1 0 1 2 3 4 06 07 08 09 10 11 12 13 14 Total, ex energy and food Food Energy Total (% yoy) Contribution to headline inflation, pp Sources: Federal Statistical Office, Deutsche Bank Research Energy component dampens inflation 6 Focus Germany 5 | November 5, 2014 Current Issues German industry: Temporary slowdown 2 — Following weak performance in winter half-year 2014/15 industrial production in Germany is likely to return to a moderate uptrend in the course of 2015, resulting in expansion of roughly 1.5% in real terms in 2014 and about ¾% in 2015. This means the generally muted dynamics of industrial performance in evidence since 2011 would continue in 2015. Industry's share in total German gross value added (2013: 21.8%) will probably decline slightly again, as in 2012 and 2013. — We expect both the automotive industry and mechanical engineering to increase their output by roughly 1% in 2015. While mechanical engineering should thus slightly improve its performance over 2014 (stagnation), the auto industry should see its growth cool noticeably (2014: +4%). Electrical engineering is poised for a round of stagnation in 2015 – following a 1.5% increase in 2014. Chemicals production is likely to add 2.5% in 2015; however, this would "only" neutralise the setbacks in 2014. — The only moderate growth of industry is primarily attributable to the currently subdued level of business activity and external shocks. Nonetheless, structural factors are going to regain importance. This is a job for Germany's politicians in particular. Many of their recently adopted measures will erode Germany's international competitiveness as an industrial location. Manufacturing: Output set to grow by ¾% in 2015 Over the past few months manufacturing performance was partly shaped by geopolitical risks and the darkening macroeconomic environment; these factors will also have an impact on the short-term outlook. At the latest reading, order intake and production were very volatile, though this is mainly attributable to one-off effects in the automotive industry (shift in the holiday-related factory shutdown period). All in all we reckon that industrial production will fall slightly in Q4 2014 versus Q3 in seasonally adjusted terms, and roughly flatline in Q1 2015 versus Q4. The expectations component of business sentiment has declined recently, pointing to subdued performance. Domestic industrial output should start to pick up again from roughly the second quarter of 2015, with stimuli likely coming both from abroad and from the home market. The production scenario outlined above will probably lead to a roughly 1.5% (real) increase in manufacturing output in Germany for 2014 as a whole. Considering that industry had started 2014 with a statistical overhang and the growth expectations at the time were still mostly positive, in the end this could almost be classed as a disappointment. The year 2014 provides another example of how largely unpredictable external shocks (Ukraine crisis) can impact actual economic performance and make it difficult to forecast. Germany's manufacturing industry is set to start 2015 with a slight statistical underhang. As a result, domestic output is likely to grow by "only" about ¾% in real terms for the year as a whole, even though we still expect an upswing to kick in from about Q2; if the recovery materialised later, however, the growth rate would even be lower. The generally very muted dynamics of industrial activity in evidence since 2011 would finally continue in 2015. In such a growth environment it would already be an achievement if the currently high employment level in German industry could be maintained. At present, some 5.2 million people are employed in the manufacturing sector; this reading is 4% higher than the long-term median. The share of industry in total gross value 2 See Auer, Josef et al. (2014). German industry: Output growth to remain shy of 1% in 2015. Current Issues. Frankfurt am Main. -30 -20 -10 0 10 20 30 10 11 12 13 14 ... on dev. of business activity ... on dev. of employment ... on dev. of production activity ... on dev. of export activity Company expectations, balance of positive and negative company reports Source: ifo Institute German industry: Decline in sentiment indicators 1 90 95 100 105 110 115 10 11 12 13 14 15 Moderate uptrend following dip in 2015 2 Manufacturing, real production index, 2010=100, seasonally adjusted Sources: Federal Statistical Office, Deutsche Bank Research 4.7 4.8 4.9 5.0 5.1 5.2 05 06 07 08 09 10 11 12 13 14 Source: Federal Statistical Office Good employment situation 3 Employees in the manufacturing industry, Germany, m Focus Germany 6 | November 5, 2014 Current Issues added in Germany is probably going to continue to decline for the years 2014 and 2015 (as already in 2012 and 2013), even though German industry is in a much better position than the rest of Europe. Germany reported a 21.8% share in 2013; the EU average was only about 15%. Major sectors: 2015 to see production ranging from stagnation to moderate growth In the automotive industry, foreign demand is the main factor underpinning Germany's good 2014 performance. The stimuli from abroad will probably lose some of their intensity as the year progresses. However, our forecast looks for full-year production to increase by no less than 4% or so. This is the best result among the major branches of industry. Foreign demand is probably going to lose momentum again in 2015. The geopolitical risks and domestic policy issues are already severely testing the tentative recovery of car sales in the euro area again. While we do not expect car demand in the eurozone to shift back into reverse, the growth rate will probably persist in the low single-digit range. In Germany, new car registrations are scarcely likely to climb faster. The value of auto exports to the United Kingdom, the United States and China is likely to grow much more slowly in 2015 than in 2014, especially since the US and China are increasingly being supplied from local production. At the end of the day, the German auto industry will probably only manage to boost output by about 1% in real terms on average in 2015. This year, Germany's mechanical engineers are feeling the reluctance of key user industries to invest and are also particularly noticing the effects of the Russia-Ukraine conflict (Russia is an important buyer market for German machinery). Their domestic output will probably roughly stagnate in real terms in 2014 as a whole. For 2015, assuming an easing of the current regional conflicts and hence a more stable global economy, we expect mechanical engineering business to gradually start picking up again in the course of the year. Mechanical engineers, who rely on investment activity in the constituent segments of their own sector and in other branches of industry including mining and construction, will probably start into 2015 without a statistical overhang. However, in the absence of political irritations in particular, there are good chances of order intake developing more favourably. An improving propensity to invest would play to German mechanical engineers' advantage, as this could help them to achieve a net increase in domestic output of 1%. One advantage for the domestic sector is that it could probably operate in a still favourable interest environment again in 2015. Furthermore, the cheaper euro in relation to the US dollar will stimulate the again better prospects for US sales. Electrical engineering is poised to raise domestic output by about 1.5% in real terms in 2014, with the sector benefiting from its dynamic growth at the start of the year. Recently, though, orders and also sentiment indicators have been trending south. Our forecast for 2015 is that output will flatline, even though production should tend to increase again in the course of the year. In the chemicals industry, output already started to fall in the early part of 2014, so the sector is likely to post a decline of 2.5% for the full year. Production has started to show signs of creeping up again lately, though. For 2015 there are good prospects of the chemicals industry neutralising its setbacks from 2014 – thanks to increasing demand from key European markets and the US. 80 90 100 110 120 130 140 10 11 12 13 14 15 +25.3% -0.4% + 1.2% +4% +13.1% +1% Growth slowing noticeably 4 Automotive industry, real production index, 2010=100, seasonally adjusted Sources: Federal Statistical Office, Deutsche Bank Research 85 95 105 115 125 10 11 12 13 14 15 +/ - 0% 13.7% +10.7% +1.2% - 1.6% Mechanical engineering, real production index, 2010=100, seasonally adjusted Sources: Federal Statistical Office, Deutsche Bank Research Still low momentum 5 +1% 90 100 110 120 10 11 12 13 14 15 +16.9% - 2.7% +10.7% - 2.1% +1.5% Sources: Federal Statistical Office, Deutsche Bank Research Electrical engineering, real production index, 2010=100, seasonally adjusted +/ - 0% Return to uptrend during 2015 6 Focus Germany 7 | November 5, 2014 Current Issues Eric Heymann (+49 69 910-31730, eric.heymann@db.com) Forecast for the major industrial sectors 7 Production Industry NACE Gross value added Export ratio Business climate* Capacity utilisation* Producer prices 2012 2013 2014 2015 EUR bn, 2012 %, 2013 Diff. yoy, Net points Diff. yoy, pp Last 12M, % yoy % yoy % yoy % yoy % yoy Food 10 26.3 21.9 - 17.4 - 0.7 0.2 0.0 - 0.2 0.0 0.5 Textiles 13 3.2 47.7 - 17.6 - 12.1 0.6 - 7.4 - 0.6 2.5 0 .5 Paper 17 9.5 40.6 - 10.9 - 0.8 0.1 - 2.1 - 1.4 1.0 0.5 Chemicals 20 34.7 56.4 - 10.9 - 0.8 - 2.2 - 2.8 0.5 - 2.5 2.5 Pharmaceuticals 21 16.6 68.6 - 29.3 4.1 0.2 - 2.4 5.3 4.0 2.0 Plastics 22.2 16.9 38.3 - 5.8 - 2.4 0.8 - 1.2 1.6 1.5 - 2.5 Building materials 23 12 .6 29.9 - 13.8 - 1.2 0.7 - 4.4 - 0.5 2.0 0.0 Metals production 24 18.7 38.8 - 11.0 - 2.5 - 4.1 - 3.7 - 0.6 1.0 0.0 Metal products 25 37.8 33.2 - 5.7 1.7 - 0.4 - 1.5 1.1 3.0 - 1.0 Electrical engineering 26+27 57.5 54.4 - 7.6 1.5 0.0 - 2.7 - 2.1 1.5 0.0 Mechanical engin eering 28 75.6 62.6 - 16.2 - 0.1 1.2 1.2 - 1.6 0.0 1.0 Automotive 29 78.2 64.9 - 9.3 3.3 0.1 - 0.4 1.2 4.0 1.0 Manufacturing 10 - 33 499.6 48.2 - 10.2 0.4 - 0.1 - 1.1 - 0.1 1.5 3/4 *Latest figure available Sources: Federal Statistical Office, Deutsche Bank Research Focus Germany 8 | November 5, 2014 Current Issues German construction activity: Robust investment, but price momentum slowing — Scarcity of supply is the key attribute of the current German real estate cycle. It seems likely to persist in the years ahead. The stricter rent control envisaged by the grand coalition does not help solve the problem but could cement the supply bottleneck. — House prices still have the biggest potential in the real estate market despite the dynamic price development in the last years. Completions and construction investments should continue to increase strongly in 2014 and 2015. — Construction investments should also rise in the public and the commercial sector. Commercial real estate should benefit from the development in the residential market and the positive economic environment. Public construction investment should get additional impulses, courtesy the debate over the modernisation of Germany’s infrastructure. — Overall, the German real estate market remains attractive due to high employment, low unemployment rates, immigration, low interest rates, a supply bottleneck, low valuations, conservative bankers and borrowers and low loan losses. These economic data forms the solid basis for our expectation that prices continue to trend higher. Germany's real estate market has seen little change this year in relation to previous years. Strong demand remains set against an inelastic, limited supply, driving up prices. However, prices are currently rising with slightly less momentum than in the past few years. Does this mean there is a trend reversal in the offing? No. The macroeconomic environment remains extremely favourable. Monetary policy is doveish, the labour market is in good shape and there is a high inflow of immigrants to Germany. German houses are still very affordable, and anecdotal evidence indicates that the German real estate markets are attracting foreign and institutional investors. The biggest risk continuing to hover over the market is the prospect of political intervention, the proposed cap on rents in particular. Since it does not eliminate the supply bottleneck but cements it in place no less, we expect a continuation of rising prices and additional investment for the time being. Labour market and immigration boosting demand for construction A robust labour market is continuing to drive demand for housing. The unemployment rate has fallen to 6.7% this year and persisted there over the past few months despite less dynamics in the economy. Employment is breaking one record after another and hit 42.7 m in August, an increase of 280,000 since the year began. This means that employment increased faster in the first eight months of 2014 than in 2013 as a whole (+230,000). The strong labour demand is being met by immigration to Germany. In 2013, Germany reported net immigration of 437,000 persons. This is the highest reading in 20 years. Most of the immigrants are from eastern and southern European countries (table 3). The stimuli should continue for a while, even though the gradual stabilisation of the labour markets in the EMU countries of origin will probably start to stem the inflow. Most of the immigrants head for the economically thriving metropolitan areas. The booming labour market has a magnetic effect on German residents though, too, as they are also flocking to the growing metropolitan areas. As a result, since 2001 the combined population of all the A-rated cities (Berlin, Dusseldorf, 95 100 105 01 03 05 07 09 11 13 A cities B cities C cities D cities Non ABCD 2001=100 N.B.: Slump linked with Census 2011 Sources: BulwienGesa, Deutsche Bank Research Population 1 - 800 - 400 0 400 800 A cities B cities C cities D cities Non ABCD Population change (2001 - 2013) 2 (’000) Sources: BulwienGesa, Deutsche Bank Research Focus Germany 9 | November 5, 2014 Current Issues Frankfurt, Hamburg, Cologne, Munich and Stuttgart) has increased by roughly 500,000, while the B-rated cities are up by 100,000 and the C-rated cities by 100,000, whereas the D-rated cities have lost 200,000 and the other (non- ABCD) cities around 700,000. These divergences in population development are also feeding through to housing demand and to the price spreads. Migration partly explains the differences in age structures in the various regions. The age ratio, defined as the number of people over 60 in relation to those aged 20-60, is much smaller in A cities – i.e. the population is younger – than in B, C and D cities (chart 4), which means the price divergence should become more pronounced between economically strong and economically weak regions in future. Low interest levels widen investor base without expansion of construction loans Another driver pushing demand is the further decline in interest rates. According to the ECB, German long-term lending rates for newbuild construction are less than 2.5% at present and thus more than 40 basis points below the level at the start of the year (2.9%). Given the still declining yields on German sovereign bonds, now less than 0.9%, and a long-term average spread of around 100 basis points, construction loan rates could fall further. However, the real estate industry itself is increasingly emphasising the risks inherent in interest rate movements which could emerge in future on further declining rates, so the adjustment to lower sovereign yields could perhaps take place only slowly or yields could in fact persist at the current level. The interest rate elasticity of demand for loans remains low. Over the past few years the strong decline in rates did not lead to a pronounced jump in lending volume. Lending to German households and domestic companies has been falling in 2014 on the whole. And while the volume of mortgage loans is creeping up, it is actually shrinking in inflation-adjusted terms – despite low inflation. This is partly because borrowers have sharply upped the rate at which they are repaying their loans. The total burden on borrowers, i.e. interest and amortisation combined, has thus declined only slightly over the past few years. Taking other criteria, too, such as the constantly high share of long-term fixed- rate loans and the little changed level of loan to value ratios, it may be seen that the construction loan market remains as conservative as ever. This dovetails with the Bank Lending Survey forecast that the volume of lending is likely to trend down in the coming months. In the third and fourth quarter, the anticipated demand for loans dropped, while the credit supply on offer persisted Immigration by country of origin in 2013 3 Immigrants ('000) GDP per capita EUR '000 Unemployment rate (%) Poland 72.9 10.1 12.5 Romania 50.3 6.7 5.2 Italy 32.9 25.6 12. 5 Hungary 24.3 9.9 8.1 Spain 24.0 21.7 24.6 Bulgaria 21.8 5.7 11.9 Greece 20.6 16.4 26.9 Russian Federation 18.6 11.0 6.0 Syria, Arab Republic of 17.0 2.0 n.a. Croatia 12.5 10.1 16.8 Total 437.3 Sources: Federal Statistical Office, Deutsche Bank Research 0 10 20 30 40 50 60 A cities B cities C cities D cities % Age dependency ratio (2011): 60+ cohort to 20 - 60 cohort 4 Sources: Federal Statistical Office, Deutsche Bank 0 20 40 60 80 100 120 140 160 180 200 90 94 98 02 06 10 Max 95% Percentile Median 5% Percentile Min House prices in cities (1990 - 2013) 5 1990=100 Sources: BulwienGesa, Deutsche Bank Research Focus Germany 10 | November 5, 2014 Current Issues at a low level. Germans’ borrowing habits are not likely to change much in future. Besides, if so, the financial supervisor (AFS) would presumably respond promptly with countermeasures. Indirectly, the globally low interest rate level continues to be a main driver of house prices and thus also an important explanatory factor for our investment forecast. The low interest level has significantly broadened the investor base and thus been instrumental in tightening supply and driving prices. Hence, national and international institutionals are continuing to take great interest in German real estate. The falling but still attractive yield levels are fundamental for their investment decisions, and volatility remains relatively low (chart 7). The way prices and rents have been developing in 2014 suggests that rental yields have fallen again though. Construction indicators pointing to expansion of supply Many indicators suggest that construction investment – following the weather- related slump in Q2 – is set to pick up again. Many indicators of the ifo business survey for the construction industry, for instance, are at high levels relative to their own history and in some cases are in fact near or at peak levels. The two indicators "order backlog" and "order backlog versus the previous month" (latest month: September) are at the 75% quartile, with the range of the order backlog and capacity utilisation in the upper 5% percentile. The favourable assessment of the ifo climate survey is generally corroborated by the order backlog reported in the Federal Statistical Office data. While incoming orders fell during the summer months on the year-earlier reading, this is probably due to a holiday effect and moreover follows the strong weather- related increase in order intake during the winter half-year 2013/14. Besides, the slight decline in the total order backlog is mainly attributable to civil engineering and road work, whereas the backlog in building construction – residential construction in particular – is expanding at a high level. The building permits trend also gives us reason to presume that the recent decline in order intake is really only a temporary dip and that order backlogs will rise to even higher levels. In 2014, building permits are already up 4% altogether on the 2013 average, with residential construction and commercial construction in particular posting increases of over 6-7%. Only building permits in the public sector have fallen noticeably (-13.2%). As the recent debate all about improving Germany's infrastructure suggests that some impetus may be forthcoming, the outlook is better than the current data. This points to potential for even higher order backlogs across all segments of the construction sector (residential, commercial and public). 0 1 2 3 4 5 6 7 09 10 11 12 13 Amortisation Mortgage rate Mortgages: Interest and amortisation 6 As % of total loan Sources: ECB, Dr. Klein, Deutsche Bank Research 0 1 2 3 4 5 6 7 8 9 90 94 98 02 06 10 Apartment, new Apartment, stock Office, central Office, periphery Retail, central Retail, periphery 1991 - 2013: Annual rental yields 7 % Sources: BulwienGesa, Deutsche Bank Research 20 25 30 35 40 45 50 55 60 65 01 03 05 07 09 11 13 15 Building permits Building completions (2 - year lag) Forecast EUR bn Sources: Federal Statistical Office, Deutsche Bank Research 2 - year lag Completions: Residential construction 8 0 100 200 300 400 500 600 700 91 95 99 03 07 11 15 Building completions: Houses 9 Total houses ('000) Sources: Federal Statistical Office, Deutsche Bank Research Focus Germany 11 | November 5, 2014 Current Issues 2014/15: Completions continuing to climb The order situation and building permits imply a further increase in building completions. In the current cycle, building permits have a lead on completions of roughly two years. The correlation is very close for residential construction in particular (chart 8); in the past, building permits were invariably higher than completions. The costs of building permits were estimated at about EUR 70.3 bn in 2012, and around EUR 76.7 bn in 2013. According to our models, this corresponds to building completions of EUR 65.8 bn (+3% yoy) in 2014 and EUR 68.4 bn (+3.8%) in 2015 (see table 11 for details). Correspondingly, we expect the number of housing completions to rise to 225,000 in 2014 and to 236,000 in 2015. Construction investment up significantly Considering the above discussion of the market situation with high order backlogs, a further increase in building permits and our expectation of an increase in building completions, we forecast that construction investment will grow by 3.3% yoy in 2014 and 2.4% in 2015. (N.B.: Near term we predict flat investment activity for Q3 2014 on the prior quarter owing to the current restraint in construction industry output.) In 2014, because of the H1 performance and the positive growth overhang, residential construction is set to make a very major contribution to growth. However, unlike in the previous years, the other construction segments also look set to make positive contributions. Commercial construction benefited like residential construction from the robust health of the economy from mid-2013, with housing and office space competing in many metropolitan areas for the existing capacities. A look at numerous cities shows that vacant office space is starting to be turned into housing. This has Building permits and building completions 11 Total Residential construction EUR bn % yoy EUR bn % yoy Building permits 01.01.2012 70.3 3.6 39.2 5.8 01.01.2013 76.7 9.1 43.7 11.7 01.01.2014 79.9 4.2 46.7 6.8 Building completions 01.01.2012 58.9 4.7 32.0 8.7 01.01. 2013 63.9 8.6 34.7 8.4 01.01.2014 65.8 3.0 36.8 6.0 01.01.2015 68.4 3.8 38.9 5.7 Commercial construction Public sector EUR bn % yoy EUR bn % yoy Building permits 01.01.2012 23.6 3.4 7.6 - 6.0 01.01.2013 23.7 0.5 9.3 22.5 01.01.2014 25.2 6.2 8.0 - 13.2 Building completions 0.0 0.0 0.0 0.0 01.01.2012 18.2 7.5 8.7 - 12.1 01.01.2013 20.1 10.6 9.1 5.0 01.01.2014 20.2 0.7 8.8 - 3.2 01.01.2015 20.6 2.0 8.9 0.1 Sources: Federal Statistical Office, Deutsche Bank Research Construction investment 2014/15 12 % yoy 2014 2015 Residential 3.8 2.6 Commercial 2.6 1.4 Public sector 2.3 3.9 Total 3. 3 2.4 Source: Deutsche Bank Research 0 2 4 6 8 10 12 90 94 98 02 06 10 A B C D % Office market: Vacancies 10 Sources: BulwienGesa, Deutsche Bank Research 80 90 100 110 120 130 05 06 07 08 09 10 11 12 13 14 Online and mail - order business Total 2005=100 Retail sales 13 Sources: Federal Statistical Office, Deutsche Bank Focus Germany 12 | November 5, 2014 Current Issues considerably helped to drive down vacancies in the office market and could trigger further investment impulses. Construction investment should also rise in the retail segment on account of the scarcity of housing and commercial space in the metropolitan areas. This follows not only from the increased migration to the metropolitan areas, but also from the positive development of private consumption, which has become one of the German economy's key growth drivers. In this context, the boom in online retail business should unleash particularly strong investment in logistics real estate. In the public sector, the improved financial health of the municipalities over the past two years has lifted their investment potential. So far, however, this has not yet fed through to higher building permits. Nonetheless, given the ongoing debate over the modernisation of Germany’s infrastructure we forecast a substantial increase in public construction investment in 2015. Rent cap cements scarcity of supply Academic literature provides virtually no clear statements on the impact of rent caps. Much depends on the details, which in local markets are often regulated by cities and municipalities. This is also the case with the current federal government bill, the details of which need to be adopted by the Bundesrat – the second chamber of parliament – before year-end in order for it to take effect at the start of the coming year. There is a possibility, however, that all the debate over the draft proposal has already caused some investment to be postponed. This could also happen in the coming year if there are legal battles between tenants and landlords over differing interpretations of a “tight housing market”, which is to be governed by the law, or else if there are squabbles over “usual local rent levels”. In any event, even if this bill does not counteract the OECD’s recommendation to bring about a structural increase in supply elasticity in the construction sector, it will simply ignore it. The macroeconomic situation of construction firms Construction firms have benefited again in 2014 from the positive price and investment trends. 2014 turnover is up more than 6% on the year with little variation across the three segments (residential, commercial and public sector). Moreover, the companies approached in the ifo business survey are certainly also benefiting from the trends of the past few years. For instance, the degree of cost coverage on prices charged is in the upper quartile relative to historical data, and the respondents are equally adamant that there is no lack of funding available. One obstacle to greater profitability and thus to higher investment in construction and faster expansion of the housing stock could be the labour supply, however. The share of companies reporting a shortage of labour is very high and the number of employees in the construction sector is growing only modestly, accordingly. Over the past five years the number of employees has increased by only 1% per year, and the number of hours worked by roughly 2%. This suggests that a training initiative and qualified inflow of migrant skilled workers and tradespeople could help raise supply elasticity, as called for by the OECD, and reduce the scarcity of housing. 0 1 2 3 4 5 60 64 68 72 76 80 84 88 92 96 00 04 08 12 Nominal Real Building permits: Commercial construction 14 EUR bn per month Sources: Deutsche Bundesbank, Deutsche Bank Research 0 1 2 3 4 5 6 7 8 60 64 68 72 76 80 84 88 92 96 00 04 08 12 Nominal Real EUR bn per month Building permits: Residential construction 15 Sources: Deutsche Bundesbank, Deutsche Bank Research 60 64 68 72 76 80 84 88 92 96 00 04 08 12 5 10 15 20 Real Median Real building permits per capita: Commercial construction 16 EUR per capita Sources: Deutsche Bundesbank, Deutsche Bank Research Focus Germany 13 | November 5, 2014 Current Issues History shows that housing supply has still not returned to normal Long-term time series help to put the current picture into better perspective. Nominal building permits per month are at high levels both in commercial and in residential construction. And real, i.e. inflation-adjusted building completions (August 2014) have been more than 10% lower than the long-term average values since German reunification and still more than 5% below the averages since 1960. Real building permits per capita are even more significantly lower than their long-term averages. This, too, suggests that the current market situation is mainly marked by a scarcity of supply. Which cities are boosting their housing supply? Activity in the current real estate cycle is spread very unevenly across Germany’s regions. For example, the metropolitan areas are experiencing a boom that is also benefiting regions which are economically strong and have good transport links. At the same time, the prices in more rural, economically weaker regions are tending to develop moderately or are even falling further. These differing price signals have still scarcely fed through in the shape of differing building completion data, which ought to underpin the continuation of the price trends in the large cities. Significance for prices The national real estate indices have recovered by around 20% from their lows of the past five years. By contrast, prices have risen by over 40% in the major cities. The most important German real estate price indices have started to flatten slightly of late. However, the trend in the big cities in particular appears to be unbroken given the scarcity of supply in these markets. The main affordability indices continue to suggest that the housing market is undervalued. For instance, the ratio of house prices to income is 14.7% below the long-term average, and the ratio of house prices to rents is 12% below the long-term average. Interest and amortisation rates are low compared to disposable income by international standards. In Germany, in contrast to many other households, this also applies to low-income households. For the banking sector as a whole the share of non-performing loans has gradually fallen, from 3.3% in 2009 to 2.7% in 2013. A decrease in non-performing loans can, in longlasting upswings, also point to market overheating. However, given the downtrend in lending growth in the current cycle in Germany, this is very unlikely to be the case. What this boils down to is that all the prerequisites are in place for further rising prices. As we stated for previous years, we expect to see prices increase again in 2015. Considering the current low price momentum, though, our forecast is not as conservative as in earlier years. Jochen Möbert (+49 69 910-31727, jochen.moebert@db.com) House price forecast for 2015 20 % yoy Single - family house Terraced house, newbuild Terraced house, stock Apartment, ne wbuild Apartment, stock Rents, newbuild Rents, stock Nation - wide 3.00 3.50 2.50 5.00 4.00 3.00 1.80 A cities 4.00 3.75 3.75 7.50 6.00 3.30 2.50 Source: Deutsche Bank Research 60 64 68 72 76 80 84 88 92 96 00 04 08 12 5 10 15 20 25 30 Real Median Real building permits per capita: Residential construction 17 EUR per capita Sources: Deutsche Bundesbank, Deutsche Bank Research 0 100 200 300 400 500 600 700 91 93 95 97 99 01 03 05 07 09 11 13 A cities B cities C cities D cities Germany Building completions 18 Number of houses (’000) Sources: BulwienGesa, Federal Statistical Office, Deutsche Bank Research 0 10 20 30 40 91 94 97 00 03 06 09 12 A cities B cities C cities D cities % Shares in building completions across Germany 19 Sources: BulwienGesa, Federal Statistical Office, Deutsche Bank Research Focus Germany 14 | November 5, 2014 Current Issues 90 100 110 120 130 140 150 08 09 10 11 12 13 14 Hypoport Multi - Family Destatis VDP BulwienGesa IMX IMXCity - 5 A cities Q1 2008=100 Indices consist of several subindices grouped together according to the Bundesbank weighting system. Sources: See legend, Deutsche Bank Research House prices: National indices and city indices 21 80 90 100 110 120 130 08 09 10 11 12 13 14 Hypoport Multi - Family Destatis VDP IMX VDP Office Office and house prices: National indices 22 1Q08=100 Indices consist of several subindices grouped together according to the Bundesbank weighting system. Sources: See legend, Deutsche Bank Research Focus Germany 15 | November 5, 2014 Current Issues Inheritance tax: Constitutional Court ruling likely to weigh harder on business heirs — The proceedings of the Constitutional Court hearing on July 8, 2014 showed that the judges had doubts about the tax relief, allowances and exemptions currently applicable to business assets. — The Court is expected to hand down its ruling in late autumn. This could lead to more restrictive regulations on business assets in cases of inheritance and gift-based transfers. In this event, the tax burden on business heirs and Germany's small and medium-sized enterprises (the Mittelstand) will increase. — The scale of the potentially heavier burden hinges partly on how restrictive the Court's specifications will be and partly on how the government would actually want to change the inheritance and gift tax in view of the revenue volume to be generated. This is already the third time that a Constitutional Court decision on inheritance tax is pending after rulings in 1995 and 2006. Even though the details of the respective points at issue differed (i.e. in the legal sense), in principle it was invariably the identical question being asked: how unequally may diverse assets be taxed in the case of a transfer by reason of succession or donation? While the previous decisions focused on the unequal valuation of different assets (such as real estate, business assets or financial assets) 3 , this time the issue is how extensively business assets may be exempted from the inheritance and gift tax. 4 The current regulation has only been in force since 2009. The new German Inheritance and Gift Tax Act (ErbStG) in force since the start of 2009 brought about – in some cases – not only higher tax rates (in tax classes II and III) but both considerably higher allowances as well as significantly higher valuations of real property and business assets. 5 These asset classes are now valued at higher levels and thus closer to market values in respect of inheritance tax than they used to be (for property assets this also applies to the real property transfer tax). Initial empirical studies show that after the new legislation on valuation came into effect the values calculated for tax purposes may prove in some cases to be considerably higher than the market prices and fair market values. 6 Under the current rules 85% or even 100% of companies (i.e. business assets) can be transferred without attracting tax. For this to happen, certain pre- requisites must be met: first, the business must be continued as a going concern for a certain period of time and, second, the total payroll must be largely maintained (i.e. there must not be any large-scale job cuts [see Box 1]). In this context, the exempted assets must be ring-fenced from non-exempted assets (administrative assets). 3 Under the old regulations (up to 2008) business assets were favoured especially by the very low valuation rates. A key part of the Constitutional Court decision was that potential steering functions of the tax not be shown in the valuation of the assets but instead openly and transparently in direct exemptions. 4 From a constitutional standpoint, the question raised is from what point the unequal treatment can no longer be reconciled with the principle of equality anchored in Germany's Basic Law. 5 See Houben & Maiterth (2013), Erbschaftsteuer als Reichbesteuerung mit Aufkommenspotenzial, p. 9ff. 6 See: Müller/Sureth 2011). Marktnahe Bewertung von Unternehmen nach der Erbschaftsteuer- reform? In: zfbf 63/11. Prerequi sites for tax allowances and exemptions on business assets 1 85% tax exemption (regular exemption ex officio): — So - called administrative assets may not exceed 50% of the business assets – otherwise the full amount is taxable — The payroll must add up to 40 0% of the starting level within five years of the asset transfer – falling short of this level leads to a pro rata loss of the exemption — In the case of disposals and mergers within the five - year period a (pro rata) share of the tax must be paid retro - activ ely. Exceptions are possible on reinvestments 100% exemption (on application): — Administrative assets must not exceed 10% of the business assets — The payroll must not be less than 700% of the starting level in seven years — Disposals and mergers are not per - mi ssible within a seven - year period. The payroll regulations are not reviewed until after the respective periods, i.e. the exemption is effective immediately at first. See Section 13a of the ErbStG. Focus Germany 16 | November 5, 2014 Current Issues The current tax law benefits not only business assets (i.e. sole proprietorships and stakes in partnerships) 8 but also stakes in (joint stock) corporations on shareholdings of over 25%. 9 There is no cap on the exemption for business assets. A further benefit is that the part of the business assets that does not fall under the exemption rules (Box 1) only has to be taxed at the lower rates of tax class I. Moreover, a tapered deduction also exists. In effect, this enables business assets of up to EUR 1 m to be transferred without attracting tax. In addition – depending on the recipient's relationship with the deceased or donor – there are also personal tax allowances (ranging up to EUR 500,000). 10 Administrative assets include, for example, property turned over to third parties for their use, stakes in joint stock corporations of less than 25%, art objects as well as securities and similar receivables if they do not serve a (financial) company's main business objective. This aspect is particularly relevant for the case being heard by the Federal Constitutional Court because it represents a pillar of the action filed. 11 Strategic tax optimisation (so-called "Cash GmbHs") 12 enabled liquid funds to be declared as "nicht schädliches 13 Verwaltungs- vermögen" (roughly: not harmful administrative assets) so that these could be transferred in their entirety without incurring tax after seven years (avoiding the 7 See also: Gutachten Beirat BMF (2012). S. 22. 8 This includes agricultural and forestry assets. See Section 13b of the ErbStG. 9 The latter also applies to indirect holdings, inter alia, but a pooling agreement is required. 10 Furthermore, firms with less than 20 employees do not have to comply with the payroll rule. See Section 13a of the ErbStG. While this applies to 90% of all companies, the remaining companies employ 60% of all workers and generate 80% of total company revenues. 11 The respective action was started by the Federal Fiscal Court with a decision from the year 2012. 12 For more on this and what follows see Bach et al. (2014), Aufkommens- und Verteilungs- wirkungen von Reformalternativen für die Erbschaft- und Schenkungsteuer, p. 14. 13 The term "harmful" focuses on the fact that the law distinguishes between business assets (or in economic terms: productive assets) and administrative assets. But it is precisely the latter that are not meant to be favoured under the Inheritance and Gift Tax Act. The term "not harmful" focuses on the fact that under certain conditions administrative assets and/or shares of the same may be exempted from tax after all and thus included as part of the actual business assets. An overview of inheritanc e and gift tax – what is taxed and how is it valued? 2 German inheritance tax is levied as a hereditary succession tax – as is the case in most countries of continental Europe – meaning that the tax obligation arises via the increase in the wealth of t he recipient (heir or donee). In contrast, in Anglo - American countries the entire estate of the testator is taxed, regardless of how this is distributed among the beneficiaries (this concept is referred to as estate tax). Fundamentally, all types of asset are liable for taxation, i.e. land and property assets, real estate, pecuniary and financial assets, other private assets and, naturally, also business assets. In this context, all related liabilities and debts may be deducted from the total value first. I t is not until the final step that tax allowances and deductions, i.e. exemptions, are applied before the going tax rate is applied to the remaining value. The assets to be transferred and taxed are valued on the basis of the valuation law reformed in 200 9. The objective is to make an assessment that approximates the market value of the assets as closely as possible. This becomes a difficult matter if – for example in the case of business assets – no market prices exist. Fundamentally, three different valu ation methods may be applied – i.e. depending on the asset in question. The valuation does not focus on the total value of the individual assets, but instead on the business as a whole. This value (referred to as the income value) is the current value of f uture cash flows. 7 Even though all the methods generally apply uniformly to all legal entities, there are nonetheless differing charges depending on the legal form, since there are differences between natural persons and joint stock corporations in the ext ent to which assets may be included as company assets. The tax rate is doubly progressive. The reason is that it forms a matrix of three classes that are geared to the recipient's relationship with the deceased or donor, with the tax rate rising on an inc rease in the assessment base within the classes. The tax rates range from 7% to 50%. Furthermore, various tax allowances exist whose level is similarly dependent on the recipient's relationship with the deceased or donor. Tax rates (since 2010) 3 Taxable value received, totalling up to EUR Tax class I Tax class II Tax class III 75,0007%15%30% 300,00011%20%30% 600,00015%25%30% 6,000,00019%30%30% 13,000,00023%35%50% 26,000,00027%40%50% over 26,000,00030%43%50% Source: German Finance Ministry Tax - free allowances (since 2011) 4 Tax class BeneficiariesAllowance Spouse and registered partner 500,000 Children, step-children, children of deceased children or step- children 400,000 Grandchildren 200,000 Parents and forebears in case of transfer by reason of death 100,000 Parents and grandparents (transfer by gift, not under Tax class I) Brothers and sisters Nephews and nieces Step-parents, children-in-law, parents-in-law Divorced spouse or partner from an annulled registered partnership III All other donees and recipients (e.g. aunts, uncles); donations for specific purposes 20,000 I II 20,000 Source: German Finance Ministry Focus Germany 17 | November 5, 2014 Current Issues payroll rule). However, since this loophole was plugged in June 2013, a key part of the current action before the Court is no longer at issue. 14 Therefore, the Constitutional Court must decide above all whether the special treatment based on the two exemption rules (see Box 1) goes too far. However, given the existing rules, the Court has considerable room for manoeuvre in its decision. Therefore, it is currently unclear how exactly the Constitutional Court will spell out its specifications for the government authorities. The tax exempt- ions are not likely to be abolished altogether. A tightening of the regulations will probably lead to a heavier tax burden, though, especially because of the higher valuation of business assets since 2009. However, politicians can exert their influence here by changing the tax rates imposed. The target of the reform in 2009 was to secure a revenue volume of roughly EUR 4 bn. Today, too, at least maintaining if not increasing this volume will probably play an important part – especially since all inheritance and gift tax revenue accrues to the Länder (federal states) and they are pushing for a bigger piece of the pie in the current negotiations on a reform of federal finances in Germany. Exemptions for business assets highly contentious from an economic perspective It is currently impossible, for the reasons outlined, to make a more accurate assessment of the potential impact on businesses. However, large family businesses would be hit particularly hard by a reorganisation of the tax regime, since ceteris paribus (i.e. barring adjustments of tax allowances and/or tax rates) the valuation of business assets can now even exceed fair market value due to the new tax rules effective since 2009. The Mittelstand is quite rightly regarded as a special source of pride in Germany as a business location because it stands for economic stability and continuity as well as a sense of entrepreneurial activity assuming responsibility for the common good. 15 An exemption for reasons of the common good is permissible under the Constitution if it is a matter of protecting jobs and/or for the sake of investment activity. It is argued that an effective exemption rule for business assets eases the transition from generation to generation and thus secures jobs while not choking off funds for investment. The latter occurs in particular if inheritance and gift tax (as a capital levy) drains liquidity from a business in the event that company earnings or assets have to be used (e.g. via divestiture) in order to settle the tax debt. From an economic perspective, however, repercussions for jobs and liquidity withdrawals are contentious points. 16 A strict separation between various types of asset can never really be achieved. The unequal treatment of asset categories leads to distorted investment decisions when considering various investment alternatives and thus also to the dominance of tax aspects in company strategy. The complaints about a liquidity drain can at least be partly defused by deferral rules or borrowing. Asymmetrical information or a lack of information in the capital markets may preclude such an approach, though. 14 Since then, payment instruments, company credit balances, pecuniary receivables, and other receivables if these represent over 20% of the business assets (Section 13b (2) 4a of the ErbStG) are deemed to be harmful administrative assets. 15 Special features pointed out in this context include financing practice, innovation activity, form of business organisation, strategic management, regional roots, emotional ties to the firm and the longevity of family businesses. 16 See Gutachten Beirat BMF (2012), p. 26ff. and Stiftung Familienunternehmen/ifo (2014), p. 3. This becomes immediately visible by the fact, among others, that for reasons of European law the exemption for business assets also includes assets located in other EU countries, which may only indirectly protect jobs in Germany. Focus Germany 18 | November 5, 2014 Current Issues A survey of family businesses conducted by the ifo Institute in February 2014 found that roughly two-thirds of Germany's family businesses believe they will have to reduce their investment activity without the exemption. 17 Nearly 50% stated that in this event they would also have to cut jobs. Nearly 40% of the companies that had experienced a case of asset transfer by reason of inheritance or gift thought that without the applicable exemptions they would have had to sell the company or at least parts of it. A survey conducted jointly by the BDI (Federation of German Industries) and Deutsche Bank found as well that nearly two-thirds of companies complained about the added bureaucratic expense caused by the Inheritance and Gift Tax Act. 18 Preferential treatment of business assets An international comparison of the tax burden on business assets is very difficult because of the very diverse valuation methods and asset transfer schemes. Exemptions on business assets are also to be found in a number of countries, though (see Box 5). If one compares the effective tax burden on family businesses using the example of a typical family business that is large by European standards 19 and which is liable for inheritance and gift tax in various countries (enabling depiction of all regulations such as valuation methods, tax allowances, tax rates), then Germany ranks in a midtable position according to ZEW model calculations (see Chart 6). The tax burden is higher in Belgium, the United States, Spain, France, Denmark and Finland, and lower in the United Kingdom, the Netherlands, Ireland and Italy. However, a number of countries do not impose any inheritance and gift tax at all (see Box 5). In a comparison of tax burdens it should be noted, too, that other countries have a number of taxes that may substitute for inheritance and gift tax. Like the inheritance and gift tax, these are geared to a company's (asset) stock or to a transfer of company assets. These include pure-play wealth taxes such as in Switzerland and France, taxes on immovable assets (above all real property tax), taxes on financial and capital transactions (e.g. real property transfer tax, capital transaction taxes). Therefore, comparison of levies on capital based on OECD figures are usually difficult to perform or are little revealing. 17 See Stiftung Familienunternehmen/ifo (2014). 18 BDI/Deutsche Bank (2013), Die größten Familienunternehmen in Deutschland. 19 The ZEW calculations assume that, among other things, the firm has total assets of around EUR 126 m and a year-end result of about EUR 4 m. In individual cases, however, the tax burden strongly hinges on the type of legal entity and the recipient's relationship with the deceased or donor. The value cited above is an average figure (weighted index). In an international comparison, sole proprietorships in Germany are better off than joint stock corporations, for instance. See ZEW (2013), Länderindex der Stiftung Familienunternehmen, 4. Auflage. As a rule, business assets tend to enjoy preferential treatment internationally 5 The preferent ial treatment of business assets tends to be the rule rather than the exception across Europe. The exemptions are usually linked, as in Germany, with certain prerequisites (mainly to continue business for a minimum period or retain a minimum stake). Signif icant valuation discounts (over 50%) are found, for example, in Finland, France, Ireland, Italy, the Netherlands, Poland, Spain and the United Kingdom. Belgium has a special tax rate of 3%. A host of countries imposes no inheritance or gift tax. These inc lude Sweden, Austria, Slovakia, New Zealand and Canada, among others. A number of countries grant a full exemption to spouses (e.g. DK, FR, IE; LU and UK) and in some of them also to their direct descendants (e.g. Poland, Slovenia, Czech Republic). 1.6 3.3 3.6 4.1 4.8 6.1 7.7 12.8 20.8 0 10 20 30 IT IE NL UK DE FR ES US BE Comparison of effective inheritance tax burden on family business assets 6 2012, EUR m, assuming total assets of EUR 126 m Sources: ZEW/Stiftung Familienunternehmen, Deutsche Bank Research Focus Germany 19 | November 5, 2014 Current Issues Consequences of potential abolition or overhaul The scale of business assets transferred in Germany has fluctuated heavily over the past few years. In the past three years the share of business assets in all taxable receipts 20 fluctuated between 20% and 40%. In 2013, the absolute value totalled roughly EUR 10 bn at the last reading (see Chart 7), and just over EUR 19 bn in 2012. In this context it is worth mentioning that after the 2009 reform heavy availment was made of the exemption rules (see Chart 8). 21 This is presumably due to the fact that many gifts were postponed in anticipation of the more favourable rules taking effect in the wake of the reform (2009). At the same time, the Federal Fiscal Court ruling of 2012 probably motivated many company owners to pull their asset transfers forward. 22 Considering the proceedings of the Federal Constitutional Court hearing in July 2014 it is likely the Court will find that the currently applicable rules go too far. It is currently impossible to forecast how restrictive the Court's specifications for the government authorities will be. Nonetheless, the burden on the Mittelstand is likely to increase – even if the government seeks to cushion the impact. Whether the extra burdens will reach a scale that leads to consequences for companies – as suggested in surveys among them – may be viewed with a critical eye, though. One possible alternative to the current exemption of business assets often brought into the equation is a broadened assessment base with low tax rates. DIW simulations modelled on microdata from the past 23 show in this case, however, that a broadening of the assessment base via abolition of the exemptions is not sufficient to generate an identical or higher revenue volume with a low tax rate of say 10%. For this to happen, the personal tax allowances, for instance, would also have to be reduced significantly. Frank Zipfel (+49 69 910-31890, frank.zipfel@db.com) 20 Only when taxable value received greater than zero. Taxable value received before deductions or allowances. 21 Note, though, too that business assets have much higher valuations since the 2009 reform. 22 Federal Statistical Office simulations modelled for the Finance Ministry quantify the reduction of revenue due to tax exemptions for business assets, ceteris paribus, at about EUR 4.8 bn per year on average between 2009 and 2012. BMF (2014). For more details see Letter to the Federal Constitutional Court for the hearing on the inheritance and gift tax on July 2014. 23 See Bach et al. (2014), Aufkommens- und Verteilungswirkungen von Reformalternativen für die Erbschaft- und Schenkungsteuer. DIW, especially p. 57ff. 0.3 10.3 10.8 5.2 19.9 Agricultural and forestry assets Immovable property assets Business assets Shares in joint stock corporations Other assets Transferred assets, 2013 7 Taxable value received greater than zero, without deductions for liabilities and allowances, EUR bn Sources: Federal Statistical Office, Deutsche Bank Research 0 10 20 30 40 50 2010 2011 2012 2013 Tax exemptions Total value of assets* Tax exemptions pursuant to Section 13a of the Inheritance and Gift Tax Act (ErbStG), including business assets and shares in joint stock corporations in particular *Taxable value acquired greater than zero Heavy availment of tax exemptions 8 Sources: Federal Statistical Office, Deutsche Bank Research Focus Germany 20 | November 5, 2014 Current Issues 25 years after the fall of the Berlin Wall: "Blooming landscapes" only in part — After the initial massive catch-up process, the real economic convergence of the east German economy has been stalling since the mid-2000s. The success regarding the convergence of living conditions was mainly reached via transfer payments, which largely materialised via social security funds. — In view of the continuing massive support of the east German Laender (federal states), the stalling convergence suggests continuing structural differences between the old and the new Laender. — True, the east German economy is likely to grow slightly more strongly than the west German economy this year, as the relatively weak development of capital spending and exports so far this year mainly hits west German companies with strong export businesses. However, in 2015, the introduction of the minimum wage of EUR 8.50 should affect the east German economy particularly strongly and raise the already relatively high unemployment among unskilled workers. — The fact that, despite massive financial support and an identical legal framework, structural factors in east Germany prevent further convergence underscores the necessity of reforms, also with a view to the current situation in the euro area. The convergence in the real economy in the euro area since 1999 is attributable mainly to the catch-up process of the east European countries. Without a fiscal union and in view of limited labour mobility, higher adjustment flexibility in the other European countries is required. "Blooming landscapes" came only later and not everywhere On November 9, 2014 the 25th anniversary of the fall of the Berlin Wall will be celebrated, the event which symbolises the end of the German Democratic Republic (GDR) and marks the beginning of the reunification process with the Federal Republic of Germany (FRG). The economic, monetary and social union took effect on July 1, 1990 and on October 3, 1990 reunification occurred. 25 years later, the public in west Germany and especially in east Germany still assess reunification positively. However, the economic challenge in view of the much more desolate state of the east German economy than presumed proved to be more protracted and above all much more expensive than anticipated. The expectation of the former Chancellor Helmut Kohl that the new Laender would soon change into blooming landscapes worth living and working in has not been fulfilled until this very day. Many for political reasons probably unavoidable strategic steps have ultimately made the adjustment process more difficult and, besides the adverse initial conditions, contributed to the fact that no full-scale adjustment of real-economy levels has been reached so far. The changeover to the common currency at parity and the sharp increase in wages due to the politically demanded conversion of wages as quickly as possible undermined the – right from the start – low international and intra-German competitiveness of the majority of east German companies. At the end of 1990 output was over 50% and employment roughly 30% below the level of the preceding year. 24 Following this reunification shock the far-reaching restructuring process began in the east German economy. This was supported by massive transfer payments, subsidies and tax relief. As a result of the initially state-supported construction boom and the powerful development of consumption – benefiting 24 Akerlof et al. (1991). East Germany in from the Cold: The Economic Aftermath of Currency Union. Brookings Papers on Economic Activity 1991 (1). -5 -3 -1 1 3 5 7 9 11 13 15 92 94 96 98 00 02 04 06 08 10 12 14* Difference in growth Old Laender New Laender * H1 2014 Convergence of East German economy stopped by the end of the 1990s 1 Real GDP - growth, % yoy, pp Sources: Statistical Offices of the Federal States, Deutsche Bank Research 0 2 4 6 8 10 12 14 16 18 91 95 99 03 07 11 New Laender Old Laender Construction, % of gross value added Temporary building boom in early 1990s in the New Laender 2 Source: Statistical Offices of the Federal States 0 10 20 30 40 50 60 91 95 99 03 07 11 Old Laender, no training Old Laender, job training Old Laender, university degree New Laender, no training New Laender, job training New Laender, university degree % Significant higher unemployment rate in the New Laender 3 Source: IAB Focus Germany 21 | November 5, 2014 Current Issues mainly west German suppliers, however – the east German economy expanded much more strongly than the west German economy up to the mid-1990s. Nevertheless, since then, growth of the east German economy has been outperformed by the west almost without exception. 25 True, the new Laender should grow slightly more strongly than the old Laender this year. However, this is no indication of new dynamics but attributable to this year's disappointing export performance against the backdrop of numerous geopolitical risks and weak economic growth in the euro zone and China. These also weigh on capital spending and hit east Germany less as a result of their lower degree of openness. High transfers from west to east German unity will probably have cost just below EUR 2 trillion until the end of this year and is a driver for the increase in all-German debt since the early 1990s. 26 Close to 60% of these costs is financed by transfers within the pay-as- you-go welfare system. The remaining 40% consists of direct transfers, such as the fiscal equalisation scheme, the solidarity pact, growth-oriented federal funding and the investment allowance. Since the start of the 1990s, east Germany's dependence on transfer payments 27 has declined from around 35% of nominal GDP to just above 20% but remains at a relatively high level. 28 In addition, the shift to the detriment of social security budgets is a negative factor. While their share in gross transfers paid in the first five years after reunification was still just below 54% on average, it grew to an average of roughly 65% on average in the last five years. Economic convergence stopped in the mid-2000s The initial slump of the east German economy and the prospects for markedly higher wages in west Germany led to strong migration movements especially of younger and highly qualified employees from the new to the old Laender. 29 This first wave of migration together with strong real growth of the east German Laender supported by massive transfer payments ensured that per capita GDP in the east German Laender rose from a level of roughly 40% of the west German level in the early 1990s to close to 60% in the mid-1990s. The second wave of migration at the start of the 2000s led to a further convergence of GDP per capita, which, however, is hovering at roughly 65% of the level of the old Laender since then. How the convergence in the real economy has developed between all 16 Laender will be examined on the basis of two convergence concepts in the following. A distinction is made between the absolute (beta-convergence) and the relative convergence (sigma-convergence). On the basis of the beta- convergence it is analysed whether there is a catch-up process of the poorer Laender. The sigma-convergence indicates how the differences between all the Laender change over time. 30 25 Gräf, B. (2012). All quiet on the eastern front, Deutsche Bank Research, Focus Germany, December 3, 2012. 26 Gross transfers minus taxes and social security contributions. Ifo Institute Dresden, IWH, calculations of Deutsche Bank Research 27 Transfer dependence is defined as net total expenditure in relation to nominal GDP. 28 Lehmann, R., Ragnitz, J. (2012). Die Transferleistungen zugunsten der ostdeutschen Bundesländer – Status quo und Ausblick. ifo Schnelldienst 3/2012 (65. pp. 25-30. 29 Schneider, L. (2005). Ost-West-Binnenwanderung: Gravierender Verlust an Humankapital, Wirtschaft im Wandel, Jg. 11 (10), pp. 309-314 30 Both convergence concepts are closely correlated. Under formal aspects, beta-convergence is a necessary but not a sufficient condition for sigma-convergence. - 200 - 150 - 100 - 50 0 50 100 150 200 250 300 91 95 99 03 07 11 Net migration New Laender Migration from New to Old Laender Migration from Old to New Laender Particularly high emigration from New Laender in ealry 1990s and 2000s 4 '000 persons Source: Federal Statistical Office 30 35 40 45 50 55 60 65 70 91 95 99 03 07 11 New Laender BB MV ST SN TH Convergence of real GDP per capita stopped in the middle of the 2000s 5 Old Laender = 100 Source: Statistical Offices of the Laender 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 9.0 9.5 10.0 10.5 11.0 Since 1991 Since 1996 Since 2001 Since 2006 y - axis: average growth since the resp. starting point; x - axis: log(GDP per capita) Beta - Convergence in Germany 6 Sources: Statistical Offices of the Laender, Deutsche Bank Research Focus Germany 22 | November 5, 2014 Current Issues Beta-convergence occurs if the Laender with an initially low GDP per capita grow most strongly und thus a negative correlation exists between average growth rates and the log of GDP per capita of the individual Laender. The fact that beta-convergence exists is reflected in the negative slope of the trend line in chart 6. Following the initially marked convergence of the new Laender to the level of the old Laender, the convergence speed has declined distinctly, how- ever, which is reflected in the lower gradient. Sigma-convergence exists if there is a convergence of the level of GDP per capita among the 16 Laender over time. Convergence is a reality when the standard deviation of the log of GDP per capita between the Laender declines over time. Between the 16 Laender, a noticeable convergence took place in the real economy. At the beginning of the 1990s, this was the result of the rapid convergence process between the old and the new Laender which came to a standstill in the mid-2000s. However, the slight drifting apart between the Laender at the end of the 1990s and the continuing moderate convergence in the real economy until the end of the 2000s was due to a convergence in west Germany. Continuing regionally different living conditions are not a typically German phenomenon, though. Compared to other large European countries, regional differences in German production per capita are currently roughly comparable to those in Spain and France. Since 2000, regional differences in these three countries have narrowed. By contrast, the differences between the regions in Italy and the UK are much more pronounced so that no or only low convergence takes place. 31 However, as a result of German history, the continuing differences attract greater attention than in other countries. Wage gap of roughly 25% from the early 2000s in line with productivity gap Due to corporate restructuring and the convergence of wages contrary to economic necessities in the 1990s, the labour-market situation has clearly darkened. This is illustrated in chart 8 which in comparison to labour productivity shows a much stronger wage convergence until the beginning of the 2000s. The catastrophic situation on the labour market – the unemployment rate rose from 12% to roughly 20% and for people without any qualification even over 50% in the early 2000s – increased pressure on trade unions to give up their course of wage convergence as quickly as possible. Thus, wage convergence almost came to a standstill. 32 However, there is a perceptible difference between the convergence of wages in the public sector and the private sector. In public service, which is protected from competition, wages converged much more strongly in accordance with the wishes of politicians and trade unions. The wage gap narrowed from roughly 45% at the beginning of the 1990s to only slightly over 5% in 2012. However, as the cost of living in the new Laender is far below that in the old Laender this convergence financed from public funds should be evaluated very critically. In the private sector, on the contrary, wage convergence came to a halt – so did convergence in the real economy – in the mid-2000s at a wage difference of around 25%. This is roughly in line with the productivity gap. Since 2005, the east German labour market was able to benefit from the increasing orientation of wages to east German productivity, and joblessness distinctly declined. 31 See also Chart of the Month “Regional convergence in Europe: No progress in Italy and the UK”on p. 25. 32 Peters, H. (2013) Convergence in pay between east and west Germany at a standstill since the early 2000s, Deutsche Bank Research, Focus Germany, April 29, 2013. 0.20 0.25 0.30 0.35 0.40 0.45 0.50 91 95 99 03 07 11 Sigma-Convergence 7 Standard deviation of log(GDP per capita) Sources: Statistical Offices of the Laender, Deutsche Bank Research -45 -40 -35 -30 -25 -20 -15 -10 -5 0 92 94 96 98 00 02 04 06 08 10 12 Total Private sector Public sector Labour productivity per employee % Monthly gross wage gap East vs. West Sources: SOEP, Deutsche Bank Research Wage convergence more advanced in public vs. private sector 8 20 22 24 26 28 30 32 34 95 97 99 01 03 05 07 09 11 East West % (population 65+ per 100 employable persons) Source: INKAR 2013 Emigration exacerbates the demographic problem in the New Laender 9 Focus Germany 23 | November 5, 2014 Current Issues However, the unemployment rate remained strongly above that in the old Laender. Continuing large challenges for the east German economy – minimum wage to have strongly negative effect The situation in the new Laender has improved strongly compared to the catastrophic situation in the GDR shortly before reunification. The development of the last 25 years shows, however, that the convergence of living conditions between regions cannot be reached overnight and that owing to different historical development paths and resultant factor endowments a full-scale convergence can probably only be attained at prohibitively high costs. Further- more, the development between the two regions underscores that the cost of wrong economic-policy decisions turns out very high. The corrections of the overly high wage increases in the 1990s, which led to a collapse of the labour market, and of the building boom induced by the government in the early 1990s took many years. What is more, transfer payments cemented the dependence of the east German economy. In retrospect, the policy of convergence was focused much too much on the demand side and transfer payments instead of creating favourable prerequisites as a location for business via reforms on the supply side. The stalling of convergence in the real economy since the mid-2000s underscores the continuing strong structural differences, such as the lack of adequate jobs in the high-wage segment in east Germany. Despite the continuing massive support of the new Laender, no further convergence was attained. In 2015, the introduction of the minimum wage of EUR 8.50 should affect the east German economy particularly strongly, though, and raise the already relatively high unemployment among unskilled workers. The biggest intrusion into the wage structure will be in Mecklenburg-Western Pomerania and Saxony where the minimum wage is roughly 70% of the median hourly wage and thus the distance to the median wage is much smaller than in the remainder of the country (50%). 33 Furthermore, in the medium term the demographic challenge will be much more pronounced for the new Laender as a result of the exodus mainly of younger and more highly qualified persons. German experience strengthens demands for structural reforms all over Europe If one takes the above-mentioned convergence criteria as a basis and uses them for the euro area, a lack of convergence is reflected here as well. True, the measures for beta and sigma convergence have improved distinctly since 1999. But this is attributable to the catch-up process of the east European countries. By contrast, the "old" EMU states even show diverging tendencies according to the sigma-convergence. The experience with German monetary union shows how difficult and lengthy convergence processes of regions with different starting positions can be even with massive (fiscal) support and high migration movements. At the same time, it underscores how disastrous the repercussions of wrong economic-policy decisions are. Within the eurozone, the readiness for a fiscal union is relatively low and labour mobility is limited due to lacking country-specific knowledge – e.g. special features of the labour market, language skills and corporate attitudes and practices. Thus, for the cohesion of monetary union to succeed, 33 Peters, H. (2014). Minimum wage of EUR 8.50 per hour: Grand Coalition on the wrong track. Deutsche Bank Research. Focus Germany. June 4, 2014. CY EE DE IR IT LV LU MT PT SK SI - 1 0 1 2 3 4 5 6 1 2 3 4 Average growth vs. log(GDP per capita) Trend EMU - 18 Trend EMU - 14* * EMU - 18 without EE, LV, SK, SI Beta - Convergence within the Euro - zone: driven by Eastern Europe 10 y - axis: average growth since1999; x - axis: log(GDP per capita) in 1999 Sources: Eurostat, Deutsche Bank Research 0.40 0.45 0.50 0.55 0.60 0.65 0.70 99 03 07 11 EMU - 18 EMU - 14* Sources: Eurostat, Deutsche Bank Research * EMU - 18 without ES, LV, SK, SI Standard deviation of log(GDP per capita) Sigma - Convergence within the Eurozone: driven by Eastern Europe 11 Focus Germany 24 | November 5, 2014 Current Issues the required adjustments to country-specific shocks have to take place within the individual countries and bold structural reforms have to be pushed through. Heiko Peters (+49 69 910-21548, heiko.peters@db.com) Oliver Rakau (+49 69 910-31875, oliver.rakau@db.com) Marcel Engelhardt Negative employment effects of minimum wage introduction mainly in east Germany 12 Minimum wage of EUR 8.50 per hour as % of median wage of full-time employee Sources: SOEP, Deutsche Bank Research Focus Germany 25 | November 5, 2014 Current Issues Chart of the month Regional convergence in Europe: No progress in Italy and the UK The article entitled “25 years after the fall of the Berlin Wall: Blooming landscapes only in part” in this edition of Focus Germany underscores that while there has been some convergence in living conditions between east and west Germany since reunification, the process of real economic convergence came to a standstill in the mid-2000s. The differences between east Germany and west Germany have remained sizeable, accordingly. In a comparison of the five largest countries of the EU, however, Germany ranks quite well on the reduction of regional differences. While the regions within Germany, Spain and France showed convergence in real economic terms between 2000 and 2011, the regional differences 34 in Italy and the United Kingdom remained largely unchanged. The two charts of country performance use the concepts of absolute (beta) and relative (sigma) convergence already discussed. In the case of beta-convergence it clearly emerges that the regions of Italy and the UK with their lower starting level posted no significantly higher growth rates on average than regions with a higher starting level. In Germany, Spain and France, by contrast, there is a very distinct negative correlation – i.e. absolute convergence. Our analysis of sigma-convergence confirms the findings. While the standard deviation of log GDP per capita within Italy and within the United Kingdom decreased only slightly or even increased and thus left these countries hovering at the year 2000's already much higher level, 35 this metric decreased noticeably in the other three countries. Heiko Peters (+49 69 910-21548, heiko.peters@db.com) Marcel Engelhardt 34 The calculations were based on Eurostat data from the NUTS 2 level. In Germany's case, this pertains to the administrative districts referred to as "Regierungsbezirke", city-states and territorial states with no further subdivision for statistical purposes. 35 The structurally higher standard deviation in Italy may be partly explained by a strong separation between the economically powerful northern regions and weak southern regions and in the United Kingdom by a concentration of economic power in London as a financial centre. 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 9.0 9.5 10.0 10.5 11.0 DE ES FR IT UK Beta-Convergence of European countries Sources: Eurostat, Deutsche Bank Research Average growth between 2000 and 2011; x-axis: log(GDP per capita) in 2000 0.15 0.20 0.25 0.30 00 02 04 06 08 10 DE ES FR IT UK Sigma-Convergence Standard deviation of log(GDP per capita) Sources: Eurostat, Deutsche Bank Research Focus Germany 26 | November 5, 2014 Current Issues DB German Macro Surprise Index The DB German Macro Surprise Index compares published economic data with market forecasts and thus provides clu es as to the direction of future forecast revisions. 36 Der DB Makro - Überraschungsindex[1] vergleicht den Wert der veröffentlichten Konjunkturdaten mit den Markterwartungen und liefert damit Hinweise über die Richtung künftiger Prognoseanp assungen. Heiko Peters (+49 69 910-21548, heiko.peters@db.com) 36 See for details Focus Germany. August, 4 2014. -0.7 -0.5 -0.3 -0.1 0.1 0.3 0.5 Jan 14 Mar 14 May 14 Jul 14 Sep 14 DB German Macro Surprise Index +/ - 1 standard deviation Average of last 20 z-scores of data surprises Values above (below) 0 indicate the data came in better (worse) than expected Sources: Bloomberg Finance LP, Deutsche Bank Research DB German Macro Surprise Index -1 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 0.8 1 05 06 07 08 09 10 11 12 13 14 Cons. Ec. forecasts, pp mom Forecast of Cons. Ec. Forecast of Cons. Ec. (10% CI) Monthly revisions of Consensus Economic Forecasts (pp); Average of previous 20 z-scores CI: 10% Confidence Intervall Sources: Consensus Economics Inc., Deutsche Bank Research DB German Macro Surprise Index: Downside-risks for GDP forecasts Last 20 published economic data for Germany DX Bloomberg Tickers Indicator Reporting month Publication date Current value Bloomberg consensus Surprise Standardised surprise Quantile rank GRZECURR Index ZEW Survey Current Situation 9 2014 16.09.14 25.4 40.0 - 14.6 - 2.1 0.0 GRIFPBUS Index IFO Business Climate 9 2014 24.09.14 104.7 105.8 - 1.1 - 1.0 0.1 GRIMP95Y Index Import Price Index (% yoy) 8 2014 26.09.14 - 1.9 - 2.0 0.1 0.4 0.7 GRFRIAMM Index Retail Sales (% mom) 8 2014 30.09.14 1.5 0.5 1.0 1.1 0.9 GRUECHNG Index Unemployment Change (000's mom) 9 2014 30.09.14 9.0 - 2.0 - 11.0 - 0.6 0.2 MPMIDEMA Index Markit Manufacturing PMI 9 2014 01.10.14 49.9 50.3 - 0.4 - 0.4 0.2 MPMIDESA Index Markit Services PMI 9 2014 03.10.14 55.7 55.4 0.3 0.4 0.7 GRIORTMM Index Factory Orders (% mom) 8 2014 06.10.14 - 5.7 - 2.5 - 3.2 - 1.5 0.1 GRIPIMOM Index Industrial production (% mom) 8 2014 07.10.14 - 4.0 - 1.5 - 2.5 - 2.1 0.0 GRCAEU Index Current Account Balance (EUR bn) 8 2014 09.10.14 10.3 13.8 - 3.5 - 1.5 0.1 GRZEWI Index ZEW Survey Expectations 10 2014 14.10.14 - 3.6 0.0 - 3.6 - 0.4 0.3 GRZECURR Index ZEW Survey Current Situation 10 2014 14.10.14 3.2 15.0 - 11.8 - 1.7 0.0 GRCP20YY Index CPI (% yoy) 9 2014 15.10.14 0.8 0.8 0.0 0.3 0.4 MPMIDEMA Index Markit Manufacturing PMI 10 2014 23.10.14 51.8 51.8 0.0 0.0 0.5 MPMIDESA Index Markit Services PMI 10 2014 23.10.14 54.8 54.8 0.0 0.0 0.5 GRIFPBUS Index IFO Business Climate 10 2014 27.10.14 103.2 104.5 - 1.3 - 1.1 0.1 GRIMP95Y Index Import Price I ndex (% yoy) 9 2014 28.10.14 - 1.6 - 1.9 0.3 0.6 0.8 GRUECHNG Index Unemployment Change (000's mom) 10 2014 30.10.14 - 22.0 4.0 26.0 0.8 0.8 GRCP20YY Index CPI (% yoy) 10 2014 30.10.14 0.8 0.9 - 0.1 - 0.3 0.2 GRFRIAMM Index Retail Sales (% mom) 9 2014 31.10. 14 - 3.2 - 0.9 - 2.3 - 1.5 0.1 Sources: Bloomberg Finance LP, Deutsche Bank Research Focus Germany 27 | November 5, 2014 Current Issues Chartbook – Total economy — The 0.2% qoq Q2 2014 GDP decline implied a much bigger payback for the strong Q1 (+0.7%) than expected. Some 0.3 to 0.4 pp of this distinctive quarterly profile are due to the m ild winter that boosted Q1 construction (+4.1%). With the usual spring acceleration not materialising the seasonal adjustment caused a significant decline in Q2 ( - 4.2%). Private consumption corrected after its Q1 surge (+0.1% qoq vs +0.8%), which was proba bly in part due to a lump - sum payment in the large retail sector in January. In H1 domestic demand was the only contributor to growth. In contrast, net exports were a drag in Q1 and Q2 (each - 0.2 pp). — German GDP in Q3 will probably have grown slightly cou rtesy of robust private consumption. Construction investment probably stagnated. Continued weakness of exports due to geopolitical risks and the poor global trade development was a drag for investments in machinery and equipment so far this year. — In add ition to the ongoing geopolitical risks (above all the Ukraine - Russia crisis) s entiment is coming under increasing pressure and question marks are hanging over the expected cyclical upturn, in part given the sluggish pace of reform in several eurozone coun tries. Disappointing economic performance in France (9% of Germany's total exports in H1 2014) and Italy (5% of exports) as well as the collapse in exports to Russia (3% of exports) are weighing more and more heavily on German exports. In this uncertain en vironment companies are likely to adopt a wait - and - see attitude and postpone some of their planned investments . Therefore, we expect growth to be weak in the winter half - year. — On account of these factors and the lowered global growth forecasts for 2015 an d 2016, we have scaled back our growth forecast s . We now expect the German economy to expand by 1.3% this year, 0.8% in 2015 and 1.2% in 2016 (prev. 2014 and 2015: 1.5%, 2016: 1.4%). Sources: Federal Statistical Office, Markit, ifo, Deutsc he Bank Research - 2 0 2 4 6 - 1 0 1 2 3 10 11 12 13 14 15 % qoq (left) % yoy (right) Real GDP growth - 1.5 - 1 - 0.5 0 0.5 1 1.5 2 12 13 14 15 16 Private consumption Government consumption Machinery & equipment Construction Net - trade Inventories GDP (% yoy) Contribution to real GDP growth (% - points) 70 80 90 100 110 120 130 08 09 10 11 12 13 14 Climate Situation Expectations ifo index - total economy (2005=100) 30 40 50 60 70 08 09 10 11 12 13 14 Composite Services Manufacturing Purchasing manager index Focus Germany 28 | November 5, 2014 Current Issues Chartbook – Foreign trade — Foreign trade disappointed strongly recently. Exports declined by 5.8% mom in August pushing the year - on - year rate down to 3% (all 3M mov. avg.). However, the August numbers were heavily distorted by a dis tinct seasonality . Imports developed also weak (+0.3% yoy) , which was probably part ly due to weak commodity prices . The trade surplus was down to EUR 18.8 bn (3M mov. avg) . — Demand for German goods slowed across all major regions in August , but the year - on - year rates remained in part relative high in positive territory (Asia: 9%, US: 8%, EMU: 4%). — It was foremost the counter - movement in automobile exports in August (negative one - offs: holiday effect, re - tooling of production lines for new models ) that drove the fall in exports. T he other German export engine, mechanical engineering, was stuttering. Foreign demand in the metal industry remained weak. — Leading external trade indicators improved, but are still on a low level and are pointing to a continued weak e xport development . The unresolved Ukraine - Russia crisis and the clouded growth outlook for some major German trading partners – esp. China, France, Italy – will pro bably continue to be a drag. Thanks to the moderate recovery of the world economy next year – driven by solid US growth – and the weaker EUR, w e expect a moderate recovery of exports with risks to the downside. Imports will probably grow relatively strong thanks to robust domestic demand. Therefore, net exports will probably dampen GDP growth (gr owth contribution: 2014F: - 0.2 pp ; 2015F: - 0.3 pp ). Sources: Federal Statistical Office, Markit, ifo, Deutsche Bank Research, CPB 0 5 10 15 20 25 30 35 40 45 50 - 30 - 20 - 10 0 10 20 30 40 08 09 10 11 12 13 14 Trade balance (right) Exports (left) Imports (left) Merchandise trade % yoy, 3M mov. avg. (left); EUR, bn (right) - 40 - 30 - 20 - 10 0 10 20 30 40 08 09 10 11 12 13 14 Total Asia USA EMU German exports by region % yoy, 3M mov. avg. - 20 - 10 0 10 20 30 40 50 10 11 12 13 14 Chemicals Elec. engineering Mech. engineering Metals Automobile Exports by sector % yoy, 3M mov. avg. - 2 - 1 0 1 2 - 30 - 20 - 10 0 10 20 30 10 11 12 13 14 15 German merchandise exports (left) Global trade (left) Manufacturing PMI - new export orders (right) ifo export expectations (right) Exports and early indicators % yoy, 3M mov. avg. (left); Standardized values (right, 4M lead) Focus Germany 29 | November 5, 2014 Current Issues Chartbook – Industry — As exports, industrial production growth disappointed in August ( - 4.0% mom; 3M m ov. avg.: - 1.7% yoy). However, these numbers overstate the weakness of underlying momentum for German industrial goods as the holiday effects and introduction of new models in the auto sector not only impacted auto production but induced second - round effec ts on the auto sector’s suppliers. These negative effects should dissipate again over the next few months. This is already obvious from the auto production numbers from the VDA for September. — The ifo index disappointed strongly in October, especially in th e light of the upside surprise from October PMIs for the manufacturing sector . On current levels both suggest that industrial growth should remain weak in Q4 . — We revised our 2014 forecast for industrial production in Germany down to 1.5% in real terms . The large industrial sectors are characterised by a heterogeneous development. The automobile industry should achieve the highest growth rate in 2014. We still expect an increase of 4 % in real terms thanks to a strong H1. Production in the mechanical engineer ing industry is likely to stagnate at best. More than others, th is sector feels the consequences of the Ukraine crisis. The crisis has also dampened business sentiment in Germany which negatively affects the propensity to invest. Domestic production in the electrical engineering industry and the metal industry could grow 1.5% and 2% respectively . In the chemical sector, however, domestic production is expected to decline by 2% after disappointing results in the first half of 2014. The food industry could se e production stagnating in 2014. In 2015, manufacturing output in Germany should expand by a mere ¾ % in real terms. Production results in the major sectors could range fro m stagnation to moderate growth. Sources: Federal Statistical Office, ifo 60 70 80 90 100 110 120 130 -40 -30 -20 -10 0 10 20 30 40 08 09 10 11 12 13 14 15 Industrial production (left) New orders (left) ifo manufacturing expectations (right, 4M lead) Industrial production, new orders & ifo expectations % yoy, 3M mov. avg. (left); index (right) -50 -40 -30 -20 -10 0 10 20 30 40 08 09 10 11 12 13 14 Total Domestic Foreign (EMU) Foreign (Non - EMU) New manufacturing orders by region % yoy, 3M mov. avg. 60 70 80 90 100 110 120 130 140 08 09 10 11 12 13 14 Automobile industry Chemical industry Electrical engineering Mechanical engineering Metal industry Production of largest industrial sectors (2010=100, sa) 50 60 70 80 90 100 110 120 130 08 09 10 11 12 13 14 Automobile industry Chemical industry Electrical equipment Mechanical engineering Metal goods ifo business expectations of the largest industrial sectors (2005=100) Focus Germany 30 | November 5, 2014 Current Issues Chartbook – Domestic economy — The German labour market maintained its overall good shape in October. Unemployment fell by 22k mom. This was, however, partly due the late timing of school holidays . Employment growth continued to be mainly driven by the integration of immigrants into the German labour market which highlights mismatch problems of the domestic labour force. The outperformance of employment relative to unemployment continues due to almost 350,000 additional persons that entered the G erman labour market this year mainly thanks to high net migration. Early indicators suggest a modestly positive development over the next few months. The unemployment rate should fall to 6.7% in 2014 (2013: 6.9%). In 2015 we expect the unemployment rate to increase slightly to 6.8% due to the weak economic situation and the negative impact from the minimum wage. — Retail sales collapsed 3 . 2 % mom in September pushing the 3M mov. avg. year - on - year rate down to 0.8%. However, this year’s September data was heav ily distorted due to the late timing of school holidays. The good weather was also a drag, because it probably pushed the typical purchases of autumn fashion from September into Q4. This is hinted by the drop of the sales volumes for textiles, clothing, fo otwear and leather goods ( - 7.3% yoy, Jan - Sep. +0.7% yoy). In addition, German retail sales are quite volatile. Thus, we see consumption as one of the strongholds of the economy . — After weakness in 2013 investment in M&E and construction spending should mode rately contribute to growth again this year. Domestic investment goods orders and capacity utilization currently point to a continued weakness in the remainder of 2014. Investment in M&E should still rise by roughly 3½% yoy in 2014 (2013: - 2.7% yoy) and ab out 1 ½ % in 2015. — The construction sector benefits from high net immigration and rising disposable income propelling housing demand. Construction spending could grow by about 3% in real terms in 2014 and 2 ½% in 2015 (2013: - 0.1%). Sourc es: Federal Statistical Office, Deutsche Bank Research, Gfk, EU Commission, ifo 85 90 95 100 105 110 115 -400 -200 0 200 400 600 800 08 09 10 11 12 13 14 15 Unemployed (left, inverted) Employees (left) ifo employment barometer (right, 6M lead) Unemployment barometer, employment and unemployment '000 yoy (left); index (right) -4 -3 -2 -1 0 1 2 3 4 -4 -3 -2 -1 0 1 2 3 4 08 09 10 11 12 13 14 Gfk consumer climate (left) EC consumer climate (left) Retail sales (right) Retail sales and consumer confidence Normalized data (left), % yoy, 3M mov. avg. (right) 96 97 98 99 100 101 102 103 -30 -20 -10 0 10 20 08 09 10 11 12 13 14 Investment in M&E DB investment climate Investment in machinery & equipment and DB investment climate % yoy (left); index normalized to 100 (right) 0 50 100 150 200 250 91 95 99 03 07 11 Construction activity New orders Construction activity and new orders 2010=100, 3M mov. avg. Focus Germany 31 | November 5, 2014 Current Issues Chartbook – Financial markets — According to the preliminary data for October inflation stood at 0.8% yoy. The fall in the oil price continued to weigh on energy prices ( - 2.3% yoy vs prev. - 2.2% yoy). Food inflatio n remained modest (+0.7% yoy vs 0.9% yoy). Core inflation remained at 1.3% yoy in October after some volatility earlier in the year. While the downtrend in oil prices is set to dampen energy inflation, the food p roducers’ price expectations suggest that food inflation could pick up further in the coming months. Also, the expected weakness of the Euro and the introduction of the minimum wage will push up prices. Our inflation forecast is 1.0% for 2014 and 1.2% for 2015. — Fearing a negative feedback loop between declining current inflation, a disanchoring of inflation expectations and still weak banking system restricting the supply of credit, the ECB has bec o me more expansionary in recent. It started the covered bond purchase programme (CBPP3) recently and will begin purchasing non - financial private sector assets under an ABS purchase programme (ABSPP) later in Q4 . Objectives are credit easing and weakening the EUR by expanding the balance sheet to early 2012 levels. However, we expect these measures to reach about half of the target ed of EUR 1 trillion. Therefore , we expect the ECB to initiate “broad - based asset purchases”, which will include government bonds, within the next six months. — Given diverging interest rate and growth expectations for EMU and the US, the yield spread between 10Y US treasuries and German Bunds has widened further to over 150 pp as of late. Sources: Federal Statistical Office, ECB, EU Commission, Global Insight, Reuters, Deuts che Bank Research -20 -10 0 10 20 -4 -3 -2 -1 0 1 2 3 4 08 09 10 11 12 13 14 Total (left) Core inflation (left) Food (right) Energy (right) Consumer prices (% yoy) 0 1 2 3 4 5 6 08 09 10 11 12 13 14 ECB refi rate 3M interest rate EMU: Refi rate & 3M interest rate (%) 0 1 2 3 4 5 6 7 8 08 09 10 11 12 13 14 US DE FR IT ES 10Y government bond yields (%) 1.2 1.3 1.4 1.5 1.6 90 100 110 120 130 08 09 10 11 12 13 14 Nom. eff. EUR - exchange rate (lhs) Real eff. EUR - exchange rate (lhs) USD per EUR (rhs) Exchange rate development for the EUR 1999Q1=100 (left), USD per EUR (right) Focus Germany 32 | November 5, 2014 Current Issues Chartbook – Lending — During 2014, shrinking processes for credit to corporates have become s omewhat less pronounced in the e urozone. With - 2. 5 % yoy, September records the smallest reduction since the start of the year. Credit to corporates in Germany shows signs of stabilization in Q 3, even mustering small yoy growth recently ( September: +0. 5 % yoy , largest increase since the start of the year ). — Household deleveraging in the e urozone continues weighing on new borrowing ( September : - 0. 7 % yoy). By contrast, lending to households in Germany continues to rise ( September : +1.2%). — The moderate credit growth in Germany is solely driven by mortgage lending. September +2 .2% yoy. Increases in mortgage credit have remained around 2% this year, in line with developments in 2013 . Given the low level for mortgage rates ( further drop in August to 2. 4 %), credit growth remains rather modest, which partly reflects portfolio shifts by households and local supply shortages. Consumer credit shrank only s lightly ( August : - 0.5 % yoy) . R ising real incomes reduc e the need to finance consumption via credit for many households translating into restrained credit demand despite the low interest rates. — Interest rates for corporate credit decreased by 5 bps to about 2.8 % in August . With key official rates at new historic low s (further decrease to 0.05% in September) , favourable interest rates for German companies persist. — C redit conditions for German corporates continue to be very favourable, even further improving s lightly in October: only 17.7% of companies from industry and trade (September 18.4%) and some 21% of construction companies (September: 21.4%) report restrictive access to credit . On balance, alternative financing options of enterprises continued to dampe n corporate loan demand though to a lower extent most recently . Sources: ECB, ifo, Deutsche Bank Research -10 -5 0 5 10 15 20 06 07 08 09 10 11 12 13 14 EMU - non - fin. corporations EMU - households DE - non - fin. corporations DE - households Lending to the private sector (% yoy) -6 -4 -2 0 2 4 6 05 06 07 08 09 10 11 12 13 14 Credit for consumption Households - lending for house purchase Loans to households (% yoy) 0 1 2 3 4 5 6 7 06 07 08 09 10 11 12 13 14 ECB refi rate Mortgage loans (households, new loans, fixed 5 - 10 years) Company loans (<1m EUR, new loans) Interest rates (%) 0 20 40 60 08 09 10 11 12 13 14 Construction sector Industry and trade Companies' view on access to credit Credit constraints: Percentage of companies reporting restrictive access to credit. Higher values indicate more restrictive access to credit from companies' perspective. Focus Germany 33 | November 5, 2014 Current Issues Chartbook – Public finances/Politics — In 2013 t he general budget only edged into the black thanks to the surpluses generated by the municipalities and the social - security scheme. The general budget for 2014 is projected to close to balance . But in 2015 the budget situation is set to deteriorate due to now weaker than hitherto expected economic growth and slightly higher unemployme nt, caused among other things by the introduction of a minimum wage. As a result the general govern ment budget will report a deficit of round about 0.5% . The German public debt ratio stood at 7 5.4 % of GDP at the end of Q 2 2014 (Q4 2013: 7 6.9 %). The still r elatively positive development reflects the small surplus in 2013 due to continuously rising revenues. In addition, refinancing costs continue to remain low. General government debt in Germany is set to decline further during the next few years, despite we aker growth dynamics. The fact that the bad banks continue to run down their portfolios will alone cut debt by 0.5% of GDP p.a. — In September , t otal tax revenues climbed by 4.8 % yoy. From January until September , t otal tax revenues were about 3 % higher tha n in the same period a year ea rlier (and thus currently only slightly below the forecast for the whole year [3.4%]). Hence the solid growth of tax revenues continues this year . Income tax is a major contributor to this development. On a cumulative basis it is over 4% higher than in the same period last year. However, the different components of income tax develop differently. T he final withholding tax on interest income and the non - assessed tax on earnings (which largely corresponds to the withholding tax o n dividends) are still lower on a cumulative basis than in the corresponding pre - year period. Regarding the final withholding tax the continuing low interest rate environment has a negative impact on the revenues. On the other hand even the revenues of the highly profit - dependent cor - poration tax now lie (on accumulated basis) above the pre - year period – thanks to unexpected prepayments for Q4 and higher back - payments for previous years. Due to the still favourable situation on the labour market and strong wage gains also the revenues of the wage tax, the most important component of the income tax, are 6% (cumulated until September) over the pre - year period. So does the VAT with a growth of 3%, main driver for this was the domestic VAT, the import VAT stagna ted recently. Sources: Deutsche Bank Research, European Commission, Bundesbank 40 50 60 70 80 90 - 5 - 3 - 1 1 3 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 Budget balance Public debt (right) Public debt and budget balance General government, as % of GDP - 5.0 - 4.0 - 3.0 - 2.0 - 1.0 0.0 1.0 2.0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 Structural Cyclical Budget balance Budget balance General government, % of GDP - 10% - 5% 0% 5% 10% 15% 20% 10 11 12 13 14 Tax revenues Monthly data, yoy and yoy 12 months moving average - 4% - 2% 0% 2% 4% 6% 8% 10% 12% 14% 12 13 14 Total tax revenues Income tax Value Added Tax Excise duties Development of important taxes Change yoy, 12 months moving average Focus Germany 34 | November 5, 2014 Current Issues Dieter Bräuninger (+49 69 910-31708, dieter.braeuninger@db.com) Nicolaus Heinen (+49 69 910-31713, nicolaus.heinen@db.com) Germany: Events of economic-, fiscal- and euro-politics DX Date Event Remarks 4 Nov ECB assumes Single Supervisor role Following the publication of the results of comprehensive assessment exercise and 12 months after the SSM regulation came into force the ECB will assume its full supervis ory tasks over the largest 128 e uro area banks. 4/6 Nov Tax estimate in Germany Tax estimates for the current year an d until 2019 are the basis for budgetary planning of the 2015 and 2016. 6 Nov ECB Governing Council meeting, press conference Review of the monetary policy stance. 12 Nov Annual Growth Survey: New Forecasts by the European Commission The European Commiss ion will outline the economic reform priorities for the EU for 2015 in the light of its growth forecasts. Given the weak economic outlook we expect that the Commission will signal some flexibility with regard to austerity targets. The Commission will also publish its assessment on macroeconomic imbalances (alert mechanism report) in EU and EMU on the same day. 14 Nov (tbc) Commission comments on draft budgetary plans of EMU countries for 2015 No rejection of national draft budgets. The assessment will also be taken into consideration when the Commission assesses the countries' compliance with the country - specific provisions set out under the Excessive Deficit Procedure in April. 21 Nov Eurogroup on draft budgetary plans The Eurogroup will review the Commis sion's assessment on draft budgetary plans and the fiscal stance across the euro area. Source: Deutsche Bank Research Focus Germany 35 | November 5, 2014 Current Issues Heiko Peters (+49 69 910-21548, heiko.peters@db.com) Oliver Rakau (+49 69 910-31875, oliver.rakau@db.com) Germany: Data calendar DX Date Time Data Reporting period DB forecast Last value 6 Nov 2014 8:00 New orders manufacturing (Index, sa), pch mom September 1.5 - 5.7 7 Nov 2014 8:00 Industrial production (Index, sa), pch mom September 2.5 - 4.0 7 Nov 2014 8:00 Trade balance (EUR bn, sa) September 21.7 18.8 7 Nov 2014 8:00 Merchandise exports (EUR bn, sa), pch mom (yoy) September 2.5 (1.0 ) - 5.8 ( - 0.1) 7 Nov 2014 8:00 Merchandise imports (EUR bn, sa), pch mom (yoy) September - 0.1 ( - 1.2) - 3.3 ( - 3.0) 14 Nov 2014 8:00 Real GDP (Index, sa), % qoq Q3 2014 0.1 - 0.2 20 Nov 2014 9:30 Manufacturing PMI (Flash) November 50.8 51.4 20 Nov 2014 9:30 Services PMI (Flash) November 55.0 54.8 24 Nov 2014 10:30 ifo business climate (Index, sa) November 103.0 103.2 - 0.3 (0.8) 27 Nov 2014 14:00 Consumer prices preliminary (Index, sa), pch mom (yoy) November 0.2 (0.8) - 0.3 (0.8) 27 Nov 2014 10:00 U nemployment rate (%, sa) November 6.7 6.7 0.3 ( - 1.6) 28 Nov 2014 8:00 Import prices (Index, sa) pch mom (yoy) October - 0.9 ( - 1.8) 0.3 ( - 1.6) 28 Nov 2014 8:00 Retail sales (Index, sa), pch mom October 3.5 - 3.2 - 0.2 0.0 Sources: Deutsche Bank Research, Federal Statistical Office, Federal Employment Agency, ifo, Markit Financial forecasts DX US JP EMU GB CH SE DK NO PL HU CZ Key interest rate, % Current 0.125 0.10 0.05 0.50 0.00 0.00 0.20 1.50 2.00 2.10 0.05 Dec 14 0.125 0.10 0.05 0.50 0.00 0.00 0.20 1.50 1.75 2.10 0.05 Mar 15 0.250 0.10 0.05 0.75 0.00 0.00 0.20 1.50 1.75 2.10 0.05 Sep 15 1.000 0.1 0 0.05 1.00 0.00 0.00 0.20 1.50 2.00 2.60 0.05 3M interest rates, % Current 0.23 0.20 0.09 0.55 Dec 14 0.35 0.20 0.10 0.55 Mar 15 0.35 0.20 0.10 0.80 Sep 15 1.30 0.20 0.10 1.05 10Y governme nt bonds yields, % Current 2.31 0.60 0.85 2.25 0.56 1.17 1.09 2.06 Dec 14 2.35 0.55 1.00 2.40 0.70 1.75 1.50 2.75 Mar 15 2.50 0.65 1.20 2.70 0.80 1.90 1.60 2.93 Sep 15 2.70 0.70 1.50 3.10 1.00 2.20 1.80 3.32 Exchange rate s EUR/USD USD/JPY EUR/GBP GBP/USD EUR/CHF EUR/SEK EUR/DKK EUR/NOK EUR/PLN EUR/HUF EUR/CZK Current 1.25 110.57 0.78 0.63 1.20 9.21 7.44 8.49 4.19 308.00 27.77 Dec 14 1.25 112.00 0.77 1.62 1.22 8.95 7.46 8.00 4.13 315.00 27.00 Mar 15 1.22 114.00 0.76 1.61 1.23 8.90 7.46 7.95 4.08 318.60 27.00 Sep 15 1.18 118.00 0.74 1.59 1.25 8.80 7.46 7.85 4.03 323.50 27.00 Sources: Bloomberg, Deutsche Bank Focus Germany German Data monitor DX Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 May 2014 Jun 2014 Jul 2014 Aug 2014 Sep 2014 Oct 2014 Business surveys and output Aggregate Ifo business climate 108.9 110.8 110.4 106.3 110.3 109.6 107.9 106.3 104.7 103.2 Ifo business expectations 106.0 107.8 106.0 101.4 106.1 104.7 103.3 101.6 99.3 98.3 P MI composite 54.5 55.4 55.2 54.5 55.6 54.0 55.7 53.7 54.1 54.3 Industry Ifo manufacturing 104.6 106.8 106.5 102.1 106.8 105.2 103.6 102.2 100.6 98.4 PMI manufacturing 52.9 55.0 52.8 51.3 52.3 52.0 52.4 51.4 49.9 51.4 Headline IP (% pop) 0.5 1.1 - 1.1 - 1.6 0.4 1.6 - 4.0 Orders (% pop) 2.1 0.1 - 0.3 - 1.3 - 2.5 4.9 - 5.7 Capacity Utilisation 83.3 83.5 84.3 84.0 83.7 Construction Output (% pop) - 0.5 5.1 - 6.0 - 2.3 3.3 - 1.4 - 2.3 Orders (% pop) 2.9 1.6 - 5.0 - 5.1 - 6.4 5.9 - 2.2 Ifo construction 121.3 122.6 120.5 119.1 120.3 120.5 119.3 119.5 118.4 118.3 Services PMI services 54.1 54.0 55.1 55.7 56.0 54.6 56.7 54.9 55.7 54.8 Consumer demand EC consumer survey - 2.8 0.3 4.3 1.0 5.5 4.3 3.9 0.3 - 1.1 - 0.7 Retail sales (% pop) 0.1 1.5 - 0.4 - 0.4 - 0.3 1.1 - 0.9 1.5 - 3.2 New car reg. (% yoy) 1.6 2.8 - 0.3 4.1 5.2 - 1.9 6.8 - 0.4 5.2 Foreign sector Foreign orders (% pop) 3.7 - 1.3 0.2 - 0.4 - 3. 2 7.5 - 8.4 Exports (% pop) 1.6 0.3 0.0 0.3 0.9 3.2 - 5.8 Imports (% pop) - 0.3 0.5 - 0.3 - 0.6 - 0.1 1.4 - 3.3 Net trade (sa EUR bn) 56.7 56.3 57.0 18.9 19.9 21.9 18.8 Labour market Unemployment rate (%) 6.9 6.8 6.7 6.7 6.7 6.7 6.7 6.7 6.7 6.7 Change in unemployment (k) 15.3 - 44.3 - 19.0 3.0 24.0 6.0 - 12.0 0.0 9.0 - 22.0 Employment (% yoy) 0.5 0.7 0.9 0.9 0.9 0.9 0.9 0.9 0.9 Ifo employment barometer 107.1 107.5 106.8 106.4 106.9 106.1 106.1 107.0 106.1 107.0 Prices, wages and costs Prices Harmonised CPI (% yoy) 1.3 1.0 0.9 0.8 0.6 1.0 0.8 0.8 0.8 0.7 Core HICP (% yoy) 1.1 1.1 1.1 1.2 0.7 1.1 1.2 1.2 1.2 1.2 Harmonised PPI (% yoy) - 0.7 - 1.0 - 0.8 - 0.8 - 0.8 - 0.7 - 0.8 - 0.8 - 1.0 Commodities, ex. Energy (% yoy) - 10.4 - 11.1 - 4.9 - 1.8 - 5.4 - 3.5 - 3.0 - 1.3 - 1.1 Oil price (USD) 109.3 108.2 109.7 102.0 109.6 111.8 106.9 101.6 97.4 Inflation expectations EC household survey 25.5 22.0 16.9 13.4 18.1 14.6 15. 3 14.8 10.0 11.1 EC industrial survey 6.1 5.6 2.3 4.2 1.9 2.6 3.3 4.1 5.2 4.7 Unit labour cost (% yoy) Unit labour cost 1.5 1.4 0.9 2.1 Compensation 1.9 2.0 2.8 2.5 Hourly labour costs 1.4 2.2 1.0 2.4 Money ( % yoy) M3 2.7 3.5 4.2 4.8 4.4 4.2 4.4 5.0 4.8 M3 trend (3m cma) 4.1 4.3 4.5 4.7 Credit - private - 3.1 - 3.6 - 3.5 - 3.2 - 3.5 - 2.8 1.0 Credit - public - 17.1 - 1.5 9.7 - 2.3 9.7 11.4 5.1 % pop = % change this period over previous period. Sources: Deutsche Bundesbank, European Commission, Eurostat, Federal Employment Agency, German Federal Statistical Office, HW WI, ifo, Markit © Copyright 2014. Deutsche Bank AG, Deutsche Bank Research, 60262 Frankfurt a m Main, Germany. All rights reserved. When quoting please cite “Deutsche Bank Research”. 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