Germany destined for recession as energy crisis ups the stakes

A nuclear reactor in Germany. Photo: Pixabay

Germany’s three-party coalition government – comprising Chancellor Olaf Scholz’s Social Democratic Party, the Greens, and liberal Free Democratic Party (FDP) – has unveiled a new €65 billion package of measures to help businesses and households cope with soaring gas prices during the winter.

The government is planning to provide help by putting a windfall tax on electricity producers. One-off payments to workers will be extended to pensioners and students. An amount of energy – still to be determined – will be supplied at a preferential rate. What is more, a new monthly travel pass is to be unveiled.

There are also plans to delay phasing out nuclear power, despite the reservations of the Greens. This has been contributing to tensions within a government that was only formed at the tail-end of last year and has had to face one of the biggest crisis in Europe since the Second World War.

Green party members are divided on the issue, but Robert Habeck, the party’s former leader and the government’s minister for economic affairs and climate action, appears to have bent to pressure from the FDP to accept some form of pragmatic solution. Germany will temporarily halt the phasing out of nuclear power to ensure its energy security. 

A full-blown energy crisis nevertheless seems quite plausible during the coming months after Russia stopped supplying gas to Europe through the Nord Stream 1 pipeline. Gazprom blamed it on a leak, although experts have stated it could be sealed and it would not be a reason to stop.

The price of gas is now double the level in December and it will only worsen in the cold weather when demand further outstrips supply.

Of course, Germany is not alone in facing such a crisis, but its investor prospects are in relative decline and it is proving more vulnerable than other large economies after becoming so dependent on Russia, now an unreliable partner, for its energy supply.

Consequently, this year alone, Germany has fallen three places in Euromoney’s global risk rankings, to 19th, with the country down six places overall on a 10-year risk trend.

The macroeconomic problems are deepening as a result. Euro Zone Barometer, a monthly survey of independent experts, predicts real GDP growth sliding, with two of the contributing panellists already predicting contraction.

One is ABN Amro, a contributor to Euromoney’s risk survey. It sees a 1.8% contraction in 2023, unemployment rising, the budget deficit widening – from 2.5% of GDP this year to 2.8% – and the debt burden up a notch to 68% of GDP.

Meanwhile, the annual rate of inflation, measured by the harmonized index of consumer prices, accelerated to 8.8% in August from 8.5% in July, which is more than double the level prevailing 12 months earlier. This will bear down on consumption, despite the low unemployment rate.

Risk expert and survey contributor Norbert Gaillard, of NG Consulting, agrees with most other analysts in figuring that the gas-supply constraints will severely affect Germany, noting also the problems posed by regional connectivity.

“German industry has been dependent on Russian gas for many years, but it has also been deeply interconnected with Poland, Czech Republic, Slovakia and Hungary,” he says. “That's the core of global value chains within Europe.”

I think the inflation rate will be above 8% in 2022 and will decline only slowly in the next few years 

 - Norbert Gaillard

These last three countries are also struggling to find alternative suppliers of gas, which is difficult because they are landlocked and have no liquefied natural gas (LNG) import capacity, unlike Croatia or Greece.

As such, Gaillard sees the German economy being affected by the “arduous position” of Czech Republic, Slovakia and Hungary. This means that in 2022 and 2023, Germany will underperform the eurozone average in terms of GDP, with the risk of recession high in the first half of 2023.

Gaillard goes on to note that the disruption to global value chains in Central Europe as well as in South Asia and China will lead to bottlenecks and feed inflation in conjunction with other factors.

He cites the trade-union agreement that just averted a strike at Lufthansa, the national flag carrier. Other similar deals are likely to occur in the next few months, he says, which could cause a wage-price spiral.

Moreover, in the medium-long term, he notes that the age structure of the German population – with the number of citizens born during 1955-1965 exceeding by far those born during 2000-2010 – suggests that the unemployment rate will remain very low and could drive up inflation.

“I think the inflation rate will be above 8% in 2022 and will decline only slowly in the next few years,” he says.

These trends could also undermine the competitiveness of Germany in the medium term, but they should contain political and social risks, “provided the government manages to preserve the standard of living of popular classes”, adds Gaillard.

The present developments, he says, should lead to a substantial decline in the survey’s economic-GNP outlook indicator and a more modest decline in the government-finance indicator, but at this stage, government stability is unchanged.

Even if that is the case, Germany’s economic woes are sufficient to drag it further down the risk rankings.