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Silvia Quandt & Cie. AG, Merchant & Investment Banking: In-between the lines – Bernhard Eschweiler
Silvia Quandt & Cie. AG, Merchant & Investment Banking / Schlagwort(e): Sonstiges – More of the same for Euro area in 2012 – Corporate strength is key support for German economy The second year of the Euro debt crisis is coming to an end and yet another year of uncertainty probably lies ahead. – A draft of the new EU fiscal pact is scheduled for release by the end of the week. Ratification by EU countries will take several months, however. Some countries may even have to call for a referendum. – EU finance ministers have pledged more than EUR170 billion to beef up the IMF. Efforts are also underway to give the EFSF more teeth and get the ESM up and running by mid 2012. Yet, that may not be sufficient and lead to fresh calls for more funds. – Focus will shift back to individual countries’ fiscal consolidation efforts with Italy in the spotlight. Pushing through the budget was already a struggle but Germany and the ECB expect Italy to do more. – All this will happen against the background of increased sovereign and banking-sector refinancing needs in the first quarter of 2012 and possibly more downgrades by rating agencies. The prospect of prolonged uncertainty will be torture for financial markets. Policymakers, especially German chancellor Merkel and ECB president Draghi, however, are unlikely to yield to market pressure soon. They believe the Euro system is more resilient – which has proven to be correct so far – and want to use the opportunity to push through fiscal governance reform. Financial market participants have not been impressed by the outcome of the last EU summit. There was too little in terms of stabilization measures. In hindsight, however, the December eighth summit may well turn out to have been the turning point. The outcome of the EU summit has been an important achievement for the German government. Chancellor Merkel is unlikely to turn soft quickly, but that kind of progress will increasingly allow her to support additional stabilization measures, including more ECB interventions. Sailing against the wind Debt crisis and the tough fiscal policy response are bad news for growth. The Euro area most likely entered recession in the fourth quarter. In fact, some countries already contracted in the third quarter. German GDP may also fall in Q4, but that will be more due to statistical distortions than underlying weakness. Best proof is the IFO survey, which actually improved slightly in November and December. The IFO survey (a combination of strong current business conditions and cautious expectations) is consistent with growth moderation but not recession. Of course, that may change, but we remain optimistic that Germany will avoid recession. First, the global cyclical environment is improving. Final demand, led by retail sales, is accelerating, most notably in the US. In contrast, output is held back by inventory adjustments. This is most visible in Asia, where production is further interrupted by the impact of the Thai floods. On the other hand, policymakers in emerging markets, notably China, are shifting from inflation fighting to growth promotion. Next year may start slow, but the combination of low inventories and firmer demand is the perfect cocktail for a production bounce. Second, Germany is the main beneficiary of easy monetary conditions in the Euro area. As we pointed out before, the Euro is very competitive from the perspective of German exporters. Furthermore, German households are not overleveraged and can take advantage of extremely low real interest rates. A housing boom is unlikely, but the IFO index provides again proof that construction is experiencing a pickup. The third support factor is the strength of the corporate sector. To be sure, firms in most OECD countries are doing better. The difference is that corporate strength in Germany is broad based. German firms are not just competitive because of cost cutting, as is the case in the US. Firms in Germany operate in a competitive environment, thanks to earlier reforms. As a result, German firms can spend part of the restructuring dividend, which is visible in the labor market. Corporate strength means economic resilience The latest Bundesbank monthly report and the recent BVR report on mid-sized companies illustrate the structural progress of the German corporate sector in general and the so-called Mittelstand in particular (see all four charts). Profitability has returned to the pre-crisis level. More important, there has been a structural lift in profit margins from below 4% of sales in the 1990s and early 2000s to above 5% of sales since 2006. A key factor has been the reduction of labor cost, thanks to more flexible employment conditions and improved productivity. Mid-sized companies also managed to use structures and equipment more efficiently, which is visible in reduced depreciation charges. Structural gains are also evident on the balance sheet. The share of equity has increased by more than two thirds for all corporates and has more than quadrupled for mid-sized companies. Correspondingly, the dependence on bank funding has declined significantly. For large companies, bank funding has become almost negligible. For mid-sized companies, bank funding is still important, but much less so than 10 years ago. Editorial note This is the last issue of In-between the lines in 2011. The next issue will be published on January 13, 2012. Merry Christmas and a Happy New Year!
Disclaimer This analysis was prepared by Bernhard Eschweiler, Senior Economic Advisor, and was first published 20 December 2011, Silvia Quandt Research GmbH, Grüneburgweg 18, 60322 Frankfurt is responsible for its preparation. German Regulatory Authority: Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), Graurheindorfer Str. 108, 53117 Bonn and Lurgiallee 12, 60439 Frankfurt. Publication according to article 5 (4) no. 3 of the German Regulation concerning the analysis of financial instruments (Finanzanalyseverordnung):
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