Current Account Surplus To Remain Too Large

BMI View: Germany's current account surplus is close to peaking. With export growth set to tail off in H214, and steadily rising import demand, we project the surplus to narrow to 7.1% and 6.7% of GDP in 2014 and 2015 respectively. However, lack of accommodative fiscal policy will prevent more rapid narrowing, to the detriment of long-term economic stability.

Weakening demand in key export markets will combine with eroding export competitiveness to drive Germany's current account surplus lower over the next few years. Timing this slowdown is hard, in large part because Germany's impressive export diversification over the past decade means it is well hedged against a slump in demand from any one market.

We believe the current account surplus peaked at EUR201bn (7.4% of GDP) in 2013, and will narrow gradually this year to EUR200bn (7.1% of GDP), then drop off more rapidly to just EUR136bn (4.3% of GDP) by 2018. However, more significant narrowing will be prevented by the authorities' desire to maintain export competitiveness at the expense of stronger consumption.

Surplus To Peak 2013
Germany - Current Account Balance, % GDP

BMI View: Germany's current account surplus is close to peaking. With export growth set to tail off in H214, and steadily rising import demand, we project the surplus to narrow to 7.1% and 6.7% of GDP in 2014 and 2015 respectively. However, lack of accommodative fiscal policy will prevent more rapid narrowing, to the detriment of long-term economic stability.

Weakening demand in key export markets will combine with eroding export competitiveness to drive Germany's current account surplus lower over the next few years. Timing this slowdown is hard, in large part because Germany's impressive export diversification over the past decade means it is well hedged against a slump in demand from any one market.

Surplus To Peak 2013
Germany - Current Account Balance, % GDP

We believe the current account surplus peaked at EUR201bn (7.4% of GDP) in 2013, and will narrow gradually this year to EUR200bn (7.1% of GDP), then drop off more rapidly to just EUR136bn (4.3% of GDP) by 2018. However, more significant narrowing will be prevented by the authorities' desire to maintain export competitiveness at the expense of stronger consumption.

Weakening External Demand

Despite the lack of data, we believe that Germany's poor industrial production reading for March this year suggests that external demand was already weakening by the end of the first quarter. This weakness was most likely caused by slumping demand from key emerging markets (EM), a result of broad-based EM FX depreciation and more specifically the fallout from the Ukraine crisis. EM demand accounts for a much smaller proportion of total exports than developed states, with China and Poland the only EMs making it into the top 10 destinations for German exporters. Nevertheless, China has become a much more important source of external demand for Germany since 2008, and our bearish view on Chinese growth is clearly net negative for export growth.

Much More Exposed To China
Germany - Exports To Top Six Export Markets, % Total Exports

The outlook for other key export destinations is also precarious. Demand from the UK, which became Germany's largest export market in Q413, is responsible for most of the recent export growth (the UK alone accounted for around half of German export growth in Q413). Our macro view is that the UK's recent growth spurt is built on weak foundations, hence our projection for the economy (and therefore demand for German goods) to slow in H214.

We also remain highly sceptical that French import demand will recover significantly this year, as the French economy is too weak to continue running persistent current account deficits in the face of collapsing foreign direct investment inflows. The only major importer to Germany that we believe is on a sustainable footing is the US, but the US outlook is not strong enough to convince us that German export growth is set for another strong performance this year.

Structural Factors To Bite

This weak external demand picture is compounded by a longer-term trend of eroding export competitiveness, which is starting to make itself felt in the country's key industrial sector. While Germany remains relatively competitive compared with its eurozone peers, the economy has lost significant price competitiveness against non-eurozone industrial economies since mid-2012, according to Bundesbank calculations (based on consumer price indices, see chart).

Relative Costs Rising
Germany - Indicator Of Price Competitiveness Against 26 Non-Euro Industrial Economies (based on CPI)

This is yet to feed through into lower export revenue, which is partly thanks to the strong pricing power of German manufacturers. Nevertheless, anecdotally we are seeing more local companies complain about rising costs, which is incentivising overseas rather than domestic investment. The most recent example of this trend was recent criticism by CEO of chemical giant BASF that energy policy in particular is having a detrimental impact on the industry.

These obstacles will only be compounded by the authorities' determination to push ahead with the costly transition towards renewable energy sources ( Energiewende), which makes German electricity costs one of the highest globally. While consumers still pay the bulk of these costs (which we believe is a key factor behind persistent current account surpluses), the European Commission recently forced a 20% reduction in the number of local companies that are exempt from paying renewable energy subsidies. Strong pricing power and an ability to absorb higher costs has so far mitigated the impact of higher costs on export revenue, but as more companies locate production overseas this will eventually feed through into weaker export growth.

Narrowing, But No Collapse

Increased overseas investment by German firms will still be positive for the current account balance if these profits are repatriated. This has been a major driver of the country's record surpluses in recent years ( see chart). The services balance has also turned positive in recent months, and although too early to confirm a trend, if sustained it would mitigate the impact of strengthening domestic demand on the current account surplus.

Income Key
Germany - Components Of Current Account, EURmn 12mma

If we are right, this means that even with stronger import levels, German demand will not play a significant role in eurozone or global rebalancing. As we have argued many times before, this has negative implications for the sustainability of the eurozone's economic recovery, which will be particularly bad news for Germany if it continues to squander its large net savings on unproductive overseas investment ( see 'Not Doing Enough With Surpluses', January 23 2014). To reverse this trend, we need to see an end to the authorities' obsession with fiscal consolidation, energy transformation and maintaining export competitiveness, none of which looks likely under the current administration.

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Related sectors of this article: Economy, Balance of Payments, Fiscal Policy
Geography: Germany, Germany
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