Germany: The Sick Man of Europe

Recent data reveals that growth eluded the German economy for the second consecutive year in 2024. However, these woes run deeper, as the economy has roughly stagnated since 2020. With the country gearing up for federal elections this February, all eyes are on potential policy changes—spoiler alert, they’re likely to be limited. Below is a look at the key challenges facing the German economy and our panelists’ outlook going forward.

Two fundamental pillars of the German economy have been rocked over the past years: Cheap energy prices and easy access to large export markets. In 2019, the country’s electricity prices were among the lowest in the EU, but in 2023 German electricity prices had more than doubled due to Russia’s invasion of Ukraine.

This reversal of fortunes shook the key industrial sector, which is expect to shrink further for the fourth straight year in 2025. Meanwhile, China’s rising share in markets formerly dominated by German firms—such as automobiles—and a likely increase in trade barriers to both the Chinese and US markets threaten external demand. Together, China and the US absorb around 16% of German exports.

Deteriorating infrastructure, lagging digitalization efforts, the government’s collapse… the list of the economy’s domestic woes goes on, but the culprit, it turns out, is the same: The federal debt brake. This measure caps the state’s net borrowing at 0.35% of GDP annually to contain the public-debt-to-GDP ratio.

Though, successful in its primary aim—Germany has the lowest such ratio among G7 countries—it has had the unfortunate side effect of limiting public investment at a time when it’s desperately needed.

Add to that excessive red tape constraining private investment, and the result is crumbling international competitiveness; according to a report by the Institute for Management Development, Germany has dropped nine places to 24th in the global competitiveness rankings in the past two years. Reforms to the debt brake require a two-thirds majority in Parliament, and are opposed by the two front-runners for the February elections. As a result, such reforms are likely a pipedream.

Though Covid-19 was successfully contained in 2021, households were plagued for a prolonged period afterwards by weak consumer sentiment, declining real wages and elevated interest rates. Heading into 2025, real income growth should pick up, which together with further rate cuts by the ECB will support consumer spending. Still, spending growth will be below the Euro average amid rising unemployment and persistent consumer negativity—in part due to lingering political uncertainty.

The Consensus is currently for the economy to post a shallow rebound in 2025 as lower interest rates and inflation drive improvements in private spending and fixed investment, and stronger EU demand fuels a recovery in exports. Still, Germany will again claim the title of the G7’s worst performer this year, held down by protracted malaise in the key industrial sector.

According to ING’s Carsten Brzeski, “The country is still one of the richest economies in the world, but it needs an overhaul to stop its gradual deterioration. Just addressing the main issues will be a challenge. Add to this unfavourable demographics and the impact on healthcare and pension systems and it’s clear that there is no easy way out of the current situation. In the absence of any new policy initiatives after the elections, the German economy looks set for another year of stagnation and possibly even a third consecutive contraction. A sad new record.”

Friedrich Schaper and Sven Jari Stehn, analysts at Goldman Sachs, said, “The early elections therefore provide an opportunity to tackle Germany’s many economic challenges. While some additional fiscal support seems likely, we believe any fiscal expansion is going to be limited in size, focus mostly on investment and support growth meaningfully only from 2026. Decisive structural reforms could boost Germany’s growth prospects—as they did in the early 2000s—but likewise take time to implement, leaving a weak growth outlook for 2025.”

Courtesy: Focuseconomics

 

 

Coalition government headed by Shehbaz Sharif in Pakistan faces daunting challenges

Newly installed government in Pakistan headed by Prime Minister, Shehbaz Sharif is facing the daunting task of managing a faltering economy with huge deficits. 

Shehbaz, 70, the younger brother of former premier Nawaz Sharif, was elected as prime minister on Monday followed by a week-long constitutional crisis after parliament ousted Imran Khan in a no-confidence vote.

“Imran Khan has left a critical mess,” Miftah Ismail, who is likely to be Sharif’s Finance Minister, told a news conference in Islamabad, adding the suspended talks with the International Monetary Fund (IMF) would be resumed on priority.

“We will restart talks with the IMF,” he said.

Ismail repeated Sharif’s concerns raised in his maiden speech in parliament at what he described as record deficits his government will inherit from Khan, who was accused by the opposition of mismanaging the economy.

Sharif set up a National Economic Advisory Council in his first meeting on Tuesday.

The IMF had suspended talks ahead of the seventh review of a US$6 billion rescue programme agreed in July 2019.

Pakistan’s current account deficit is projected at around 4% of GDP for the current fiscal year (FY22), the country’s central bank said last week. The foreign exchange reserves held by Pakistan dropped to US$11.3 billion as on April 01, 2022 as compared with $16.2 billion less than a month earlier.

The central bank last week hiked key interest rates by 250 basis points to 12.25% in an emergency decision, the biggest hike in decades, citing deterioration in the outlook for inflation and an increase in risks to external stability, heightened by the Russia-Ukraine conflict, as well as local political uncertainty.

The bank also revised average inflation forecasts upwards to slightly above 11% in FY22, ending June 30, 2022.

Dawn, leading English newspaper of Pakistan in its Editorial on April 12, 2022 has highlighted that Shehbaz Sharif has inherited some daunting challenges. These include, but are not limited to, a worsening economic crisis, growing political turmoil, deteriorating relations with the Western powers, and the resurgence of militancy in some parts of the country.

The Editorial says, “We have no idea whether the ruling coalition that consists of disparate parties and groups, with often conflicting political and economic aims, will stick together until the elections are called. They may have achieved their common goal of ousting Imran Khan from power, but facets of their long-term plan are still to be revealed.”

“With the PTI quitting the National Assembly and pledging to build up strong public pressure on its successors for early elections in the country, it will not be all smooth sailing for the new administration.”

It continued, “Fixing the broken economy is probably the most formidable challenge facing Sharif’s cabinet, and he should place it on top of his agenda. The PTI had inherited a bad economy that it has left in far worse condition; ordinary people are grappling with elevated double-digit inflation, as well as wage and job losses, as macroeconomic indicators decline.”

“The crisis of balance of payments is already back, after a short Covid-related respite, as much-needed multilateral assistance is on hold because of uncertain political conditions in the country. Elevated international commodity prices, particularly food and crude oil, are putting additional pressure on a frail external sector.”

Improving the economy requires tough decisions, such as the immediate removal of the cap on electricity and petroleum prices and renegotiating a new loan with the IMF, which will be hard, if not impossible, without repairing diplomatic relations with the United States and other Western powers.

The biggest question is, can the ruling coalition take these politically unpopular but vital decisions?

New elections are not very far off, and Imran Khan’s PTI will be scrutinising and criticising every move of the new set-up. The populist announcements, like the 10pc raise in pay and pension of government employees and the provision of subsidised wheat flour, made by Shehbaz Sharif in his speech in the House, soon after his election as prime minister, are indicative of the extreme pressure he must be feeling.

With forbidding political and economic realities on one side and high public expectations on the other, the coalition government and its leader do not have too many options on the table as they get ready to deal with multiple crises, at least not at the moment.

The enormity of the economic and foreign policy challenges demands a strong government, which is not encumbered by uncertainty over its future and has the public mandate to take tough and unpopular decisions. The wiser course would be to reform the electoral laws and move towards new elections at the earliest.