Energy crisis to weigh on short- and medium-term growth prospects

Following a -4.1% drop in economic output in 2020, the German economy took longer to recover from the Covid-19-induced growth setback compared to Eurozone peers due to persistent supply-chain bottlenecks weighing on industrial activity. Despite GDP expanding by +2.6% in 2021, pre-crisis GDP levels were only reached in early 2022 – whereas the Eurozone aggregate already hit that milestone in late 2021.

Following a strong first half of 2022- thanks to the post-omicron rebound in services – the German economy looks set to slip into recession at the turn of 2022/23, given the strong headwinds triggered by Russia’s war against Ukraine, including high inflation, elevated geopolitical uncertainty and fresh supply-chain stress. Forced gas rationing in the winter has become less likely, thanks to gas storage facilities filling up faster than expected, but energy-intensive industries and consumers have shifted into self-rationing mode amid double-digit inflation, pointing to a notable decline in activity. To counteract the negative effects and support the economy, comprehensive fiscal support was implemented during both the pandemic and the energy crisis at the expense of diminishing policy space. So far, announced energy-related fiscal measures have amounted to around 8% of GDP. Meanwhile, in light of cooling global demand and prolonged supply bottlenecks, net exports will not save the day despite a weak EUR. We expect GDP to expand by +1.6% in 2022 before contracting by -1.3% in 2023. Next to dim short-term prospects, the medium-term outlook is also concerning, given structural headwinds including higher energy prices, interest rates and geopolitical uncertainty.

In Germany, we expect insolvencies to remain below 2019 levels despite a rebound in 2023 that would reach +17% y/y i.e. +2,450 firms to 17,150 cases. We expect the government to avoid supporting non-viable firms but the massive EUR200bn economic “shield” will limit the impact of the energy crisis on businesses. In addition, we expect the government to remain ready to act in a targeted way, as they did to rescue several most-hit utilities, including by making extra temporary adjustments to restructuring and insolvency laws, and by temporary suspending the obligation to file for insolvency if needed – for instance in case of additional major issues in supply chains in manufacturing. We estimate that the current fiscal support is reducing the rise in insolvencies by -12pps in Germany (or saving 2,600 firms) on average over 2022 and 2023.

Following Russia’s invasion of Ukraine, the German government announced substantial fiscal measures to tackle the energy crisis. As the German government is trying to pursue a prudent underlying fiscal stance consistent with the domestic debt brake, this has led to around EUR400bn being amassed in off-balance sheet spending (EUR100bn for military upgrade, EUR200bn to subsidize energy prices and EUR100bn for climate investments). Strong growth in tax revenues will help improve the fiscal position in 2022/23. Overall, we expect the budget deficit to average around 3% over the forecast horizon after 3.6% in 2021. Government debt looks set to stabilize just below 70% of GDP.