Deutsche Bank : Germany's massive current account surplus set to decline

Current Issues

Germany

• The Eurozone's current account (CA) surplus has lent some support to the euro over the past two years at a time of relentless Fixed income outflows. Germany is pivotal, as it accounts for 60% of the surplus. This report argues that the German surplus is likely to weaken by about 20% to 7% of GDP by the end of the decade.

• Since the rotation of fixed income assets out of Europe is likely to continue - a dynamic we have referred to as 'Euroglut' - the balance of payments should therefore become even more bearish for the euro.

• Unfavourable demographic trends and the domestic housing boom will be most detrimental to the surplus. Both factors will lower household saving ratios and are likely to result in higher import demand. As a new factor to this mix, record levels of immigration will accelerate the decline. Directly, it will raise import demand for foreign goods as well as remittances into home countries. Indirectly, the integration in the housing market is likely to cement excess demand for years to come and help drive real estate prices higher.

• Externally, accelerating global growth relative to Germany's cycle will benefit net export demand, but the net effect will be limited by the fact that global trade will probably remain subdued. The aftermath of 'Brexit' and weak demand from oil-exporting economies are particularly concerning for German exporters.

• While our results are model-driven, we also provide deep dives into the main drivers of the German current account: the housing market, international trade and demographic change, including migration.

Germany's CA surplus set to fall by 20% due to demography, housing boom and slowing globalisation 1

% of GDP %, pp

10

8

6

4DBe

2

0

-2

-4

95 99 03 07 11 15 19

10

5

0

-5

-10

-15

-20

-25

Global cycle

Demography

Housing

market

Global

value chains

Total

(%)

Source: Deutsche Bank Research

Germany's balance of payments is the pivot for global imbalances

The Eurozone as the world's largest surplus region

Top-5 largest current account

surplus/deficit countries 2

Country CA balance NIIP USD bn (2015, 3y avg)

Sources: IMF, Deutsche Bank Research

Global current account imbalances remain markedly below the pre-crisis peak. While the US retains the largest current account deficit, other regional imbalances have shifted in recent years. While the Chinese and Japanese surpluses have shrunk and oil exporters' balances tipped negative in 2015 for the first time in seventeen years, low oil prices also allowed the Eurozone to emerge as the main surplus region. In the year to June, the Eurozone's surplus remained close to its highs (EUR 348bn or 3.3% of GDP).

'Euroglut' drives euro and global yields

On the financial account, fixed income outflows from the Eurozone also soared to record levels, with Eurozone investors searching for yield as aggressive ECB easing and prospective Fed tightening widened interest rate spreads. The yield for 10-year government bonds in the Eurozone has collapsed from 1.9% at the start of 2014 to -0.1%. Currently 60% of government bond yields in the Eurozone are in negative territory; and a staggering 88% of German bunds.

Over the past year net portfolio investment outflows peaked at more than EUR 500bn. In previous research, we referred to these massive fixed income outflows as "Euroglut"1.

Thanks to these large capital outflows, the broad basic balance-the balance between the current account balance on the one hand and FDI and portfolio flows on the other-fell deep into negative territory. This striking decline in the broad basic balance was the main driver behind the euro's collapse after mid- 2014 and has also had implications for global asset prices.

Partly these outflows simply recycle the current account surplus, but the fact that fixed income outflows have run at almost twice the rate of current account surpluses also suggests that European investors have been rotating asset stocks out of the Eurozone. Hence, importantly, a deteriorating current account

1 DB Special Reports: Euroglut a year on: alive and kicking, EUR/USD to break parity, 1 December 2015. Euroglut: a new phase of global imbalances, 6 October 2014 and Euroglut Revisited: The German Saver, 9 December 2014.

surplus need not necessarily be offset by falling capital outflows. In our view, it would most likely weaken the basic balance even more. This implies that even more EMU assets will probably be exchanged for non-EMU assets.

Slump in EMU broad basic balance… 5

EUR bn, 12M moving sum

Sources: Eurostat, Deutsche Bank Research

Germany is the main contributor to the EMU's record surplus

As Europe's export powerhouse, Germany has contributed most to the Eurozone's surpluses. Presently the German share amounts to almost 60% once adjusted for intra-EMU flows. Moreover, almost half the EUR 300bn increase in the Eurozone's current account surplus since 2010 is due to Germany. As implied by the balance-of-payments data, German savers also account for the bulk of net saving in the Eurozone. While in the rest of the Eurozone private saving offsets public dissaving, in Germany both sectors are net savers (figure 9).

With net portfolio investment outflows of EUR 206bn,2Germany is also responsible for 40% of the capital flows out of the Eurozone, though the flows are more difficult to disentangle. It is not possible to exclude the German flows from the Eurozone flows with the rest of the world as a large part of the German extra-EMU portfolio investments are channelled through the investment funds issued in Luxembourg and Belgium. These funds probably invest a substantial share in assets outside the Eurozone. Over the past four quarters, cumulated net portfolio flows to Luxembourg and Belgium amounted to EUR 147bn and to EUR 510bn, respectively.

Hence, Germany is pivotal for the Eurozone's balance of payments3and related movements in the euro. The rest of this report therefore attempts to project the German current account in particular until the end of the decade, which maps onto our forecast horizon for the euro.

2 Rakau, O. (2015). Investing the German household way: A little more risk. Focus Germany. 30 April 2015.

3 Note that one cannot deduce any direction of causality from balance of payments identities.

Germany accounts for almost 60% of EMU's current account surplus EUR bn, 4Q moving sum, Extra-EMU flows

Sources: Eurostat, Deutsche Bank Research

Strong increase of the German NFC's

% of GDP

6

4

2

0

-2

-4

-6

What drives the German surplus?

From the balance-of-payments perspective, it is goods trade that has clearly been behind the steep increase since 2000 (figure 12). This narrative of Germany as an export powerhouse is well known. But it helps to look at the surplus from a flow-of-funds perspective.

We can split the current account into net saving in the corporate, public and household sectors. Most of the increase in net saving since 2013 was driven by the non-financial corporations that increased from 1.7% in 2013 to 3.5% of GDP

91 95 99 03 07 11 15

Net investments Savings gap Savings

Sources: Eurostat, Deutsche Bank Research

Interest payments of the general

% of GDP

7

6

5

4

3

2

1

0

in 2015. Net investment remained very moderate, expanding by only about

0.5% of GDP, as capacity utilization level was at its long-term trend, the output gap remained negative and the global outlook was far from bullish. Thus, corporations largely retained profits provided in part by oil-price related windfall gains and reduced interest payments caused by the aggressive ECB policy.

Despite surging refugee-related spending, the public sector surplus increased over the same period amounting to net savings of 1.2% of GDP, largely thanks to the healthy labour market causing buoyant tax revenues and to lower interest rate payments.4

The household sector continues to have the highest savings gap and increased net saving to 4.9% of GDP in 2015 (or 8.1% of disposable income). Strong real wage increases and also the oil-price related windfall income gains were the main drivers.

95 99 03 07 11 15

DEU EMU EMU ex DE

Source: Eurostat

4 Rakau, O. (2015). Euro area NFCs: Flush with cash, but lacking investment opportunities. Focus Europe. Deutsche Bank Research. 7 August 2015. Interest savings on their own alone explain almost half of the higher savings gap. Interest payments of the general government fell by EUR 7.5bn to 48.5bn or 1.6% of GDP in 2015.