Q4 German GDP Depressed by Plunging Exports and Weak Equipment Spending

According to detailed data from the Federal Statistical Office (FSO), real GDP in the fourth quarter of 2008 posted a record contraction of 2.1% quarter-on-quarter (q/q), adjusted for seasonal and calendar factors. This confirms the preliminary number released on 13 February, and follows declines of 0.5% q/q in the two preceding quarters and one final surge of 1.5% q/q in the first quarter of 2008. Year-on-year (y/y) growth, again calendar adjusted, fell from 0.8% in the third quarter to -1.7% in the fourth. There was only a minimal working-day effect in the fourth quarter, meaning that unadjusted annual growth was -1.6%. This compares with 3.4% only two quarters prior to that, when three additional working days helped. The cyclical peak had been close to 4% in late 2006, when the looming value-added tax (VAT) hike had led to purchases being brought forward. Meanwhile, the mid-January release putting preliminary 2008 GDP growth at 1.0% (1.3% unadjusted) has been officially confirmed.

Net Exports Constitute Huge Burden on GDP Growth

The breakdown by individual expenditure components shows that net exports were the key negative contributor to GDP growth in the fourth quarter, just as in the third. The difference is that the third-quarter drop was largely due to an interim surge in imports, whereas in the fourth quarter plummeting exports were responsible. Exports, which until early 2008 had held up quite well in the face of the initial financial-market turbulence, a strengthening euro, and rising input costs, were hit extremely hard by the collapse in global demand during the latter months of 2008, falling 7.3% q/q. Imports declined by only 3.6% q/q as domestic demand weakened much less initially and as sharply lower import prices had a supportive impact (both directly, given a negative import price deflator, and indirectly by encouraging consumer and corporate purchases of now cheaper imports). Net exports therefore subtracted 2.0 percentage points from quarterly GDP growth in the fourth quarter, the largest dampening effect for a single quarter since 1991. This followed a net exports burden of 1.8 percentage point in the third quarter, meaning that the external sector has indeed been responsible for the bulk of Germany's sharp economic slowdown since mid-2008.

Fourth-quarter developments had already been indicated by the monthly merchandise trade data, with exports in nominal and seasonally adjusted terms plunging by 11% month-on-month (m/m) in November and another 4% m/m in December. The purchasing managers' index (PMI) sub-index for export orders had already moved into contraction territory in May—for the first time since July 2003—and hit an all-time low in December, remaining at this extreme level in January and February. As long as overall world trade remains so weak, positive factors such as German exporters' strong competitive position or the euro's marked downward correction since mid-2008 cannot have much of a supportive impact. Indeed, with Germany's export strength lying in areas related to investment (notably plants and machinery), sustained improvement will only come once emerging economies can overcome the current crisis and return to their long-term structural adjustment paths.

Most Domestic Demand Components Decline Only Modestly

Domestic demand components revealed only modest deterioration in the fourth quarter, except for investment in equipment. The overall impact of domestic demand on quarterly GDP growth was -0.1 percentage point, but the bulk of this resilient performance owed to another build-up of stocks, which contributed 0.5 percentage point. This followed a boost to GDP of even 1.0 percentage point in the third quarter. Inventories have shown frequent swings between additions to and subtractions from GDP growth from one quarter to the next since the start of 2006. The expenditure breakdown also shows that both private consumption and construction investment subtracted merely 0.1 percentage point from GDP growth, while government consumption stagnated. Only investment in equipment weakened significantly (down 4.9% q/q), which dampened quarterly GDP growth by 0.5 percentage point.

Looking at the components in further detail and concentrating on q/q changes, private consumption slipped by 0.1% q/q, correcting for part of its third-quarter recovery of 0.3% q/q. The latter had been the first increase after three consecutive quarters of decline (averaging 0.4% q/q) caused by the inflation surge between mid-2007 and mid-2008. It is entirely thanks to the about-turn towards declining inflation in mid-2008 that consumer spending has been able to stabilise during the last two quarters. Rising unemployment has only become a topic since December; this will gain prominence for consumption prospects in the coming quarters. Government consumption has been surprisingly weak of late, not only because of the flat performance in the fourth quarter but also as third-quarter growth was revised downwards from 0.8% to 0.3% q/q. Public consumption had still been increasing at a pace of almost 1% q/q during the first half of 2008, which may have been linked to persistently healthy tax revenues that loosened the fiscal reins on expenditure. The worsening financial market and economic crisis since September will keep fiscal policy on an expansionary course, but this will show up more in terms of public investment rather than in government consumption numbers.

Fixed investment as a whole fell 2.7% q/q, a marked worsening from the third quarter (up 0.2%) that was mainly caused by a sharp drop in investment in equipment (down 4.9% q/q). Construction spending weakened by much less (down 1.3% q/q), even though a severe winter had already had an impact in December. Equipment spending has been weakening continuously in recent quarters, but it has now entered negative territory in such significant fashion for the first time since 2002, testifying to the depressing influence of the global economic crisis of late. Prior to the fourth quarter, the manufacturing sector had still benefited from a large backlog of orders stemming from late 2007.

Finally, the addition of 0.5 percentage point to fourth-quarter GDP growth from inventories largely reflects the suddenness of the drop in demand, forcing firms to pile up stocks involuntarily. Separately, the ongoing cheapening of inputs due to much lower commodity prices may also have contributed by enticing some firms to stock up on raw materials. Overall, domestic demand minus inventories thus subtracted 0.6 percentage point from GDP in the fourth quarter, compared with a small positive contribution of 0.2 percentage point in the third quarter and a negative contribution in the second quarter (of 0.5 percentage point). The trend for domestic demand minus inventories is still pointing downwards for most of 2009, although remaining more limited than the decline in overall GDP growth, which also suffers from negative net exports.

Only Minimal Calendar Effects Distort Q4 Data

Unlike the large positive influences on unadjusted annual growth rates in the second and third quarters (of 1.4% and 0.6%, respectively), there was only a minimal working-day effect in the fourth quarter amounting to 0.1 percentage point. Thus the unadjusted y/y growth rate of -1.6% was only slightly higher than its adjusted counterpart at -1.7%. Due to the bigger influence in the two preceding quarters, the deterioration in growth in unadjusted terms (from 3.4% to -1.6% y/y) is much more pronounced than that in calendar-adjusted terms (from 2.0% to -1.7%). Looking ahead, there will be another only small impact in the first quarter of 2009 (+0.2 percentage point) but a large depressing effect in the second quarter (-1.4 percentage point), meaning that the (unadjusted) headline y/y rate will look absolutely dismal in the second quarter of 2009. This could easily extend to around -5% y/y.

Outlook and Implications

The extent of the contraction in the fourth quarter of 2008 illustrates the huge importance of global demand to German economic growth. Stabilisation of the financial markets and global growth forces are therefore of paramount importance if Germany is to stage an economic recovery. The concurrent collapse in inflation at present certainly supports private consumption, but this cannot anything like compensate for the massive downward impulses affecting exports and investment.

Germany's economic growth will remain negative at least until the second quarter of 2009, although the pace of contraction will become much slower after the initial demand shock of recent months, especially to exports, has been digested. Nevertheless, net exports will remain the biggest burden on growth throughout most of 2009, as a result of persistently weak global demand. The much softer euro of late will hardly offset this, as the pace of growth in foreign countries is a much more important variable for German exports than the exchange rate. Together with relatively more resilient imports—as German consumers do not need to cut back as much as elsewhere in Europe—the external contribution to GDP growth should remain negative throughout most of 2009. In addition, investment in equipment is now most likely to contract at a double-digit pace in 2009, given that capacity utilisation rates have plunged in recent months, creating a widening output gap. The record pace of the decline in orders of late, notably for investment goods, suggests that even a gradual recovery in this area will not occur before around mid-2010.

That said, Germany's persistent advantages in terms of its competitiveness compared with most of its Eurozone partners should enable a relatively rapid rebound in both exports and investment once global demand recovers. The main supporting influences in the interim will be the ongoing decline in inflation and the increasing impact of both monetary and fiscal stimulus measures that are currently in the pipeline, as these should prevent overly sharp private consumption declines despite rising unemployment.