|
Why do the Germans appear so gloomy when apparently they have every reason to be cheerful? All the indicators are right; interest rates are at an historic low and there is little prospect of rate rises in the near future. The Dax index of leading German shares storms almost daily from one record to another, propelled by optimism about leaner management, better returns for shareholders and further consolidation in sectors like banking and car manufacturing. The feelgood factor has also spilled over into the financial sector. Monthly trading on the German stock exchange was almost double 1995 volumes last year and investors are turning over their German stock and bond portfolios at an unprecedented rate. Borrowers want to issue debt sooner rather than later with the Deutschmark yield curve so steep. Emerging-market borrowers are also taking advantage of unprecedented low interest rates to borrow Deutschmarks. Even the federal government is thinking of borrowing ahead of its needs by issuing 30-year bonds. It is just as well for the German government that the financial market is in such a buoyant state. Bonn has not forgotten how, at the beginning of the 1990s, the vast sums it borrowed to rescue the eastern German economy drove interest rates up dramatically to unprecedented levels. The cheer in the financial markets infact conceals a deep malaise, for Germany’s economy is once again in dire trouble. The economic difficulties Germany faces are more serious than any recession. Its severest critics say that the country’s economy is beset with structural problems. Industry is still dominated by traditional manufacturing and too much of the economy relies on state spending. With nearly five million unemployed, some regions depend almost entirely on public-sector transfers, reminding east Germans of their years under state socialism. It is seven years since the Kohl government began its rescue of eastern Germany’s economy by restructuring the country’s ravaged infrastructure, introducing a social security and taxation system and replacing the useless Ostmark with the Deutschmark. But the transformation is nowhere near complete. The government will have to go on bankrolling eastern Germany for some years to come. At the same time, the west German economy has also suffered. For years, German industry compensated higher wage costs with superior quality goods, but as wage costs have spiralled ever-higher and the quality of goods from lower-wage countries improves, the equation no longer works. Even in eastern Germany, it did not take long after currency union in 1990 for industries to become too laden with costs to be competitive. Inevitably, all this has led to higher unemployment, a huge social security burden, and increased government borrowing. Finance Minister Theodor Waigel has promised that Germany will reduce its budget deficit to the Maastricht level of 3% of GDP by the end of the year; few believe him. The same goes for his pledge to keep net new federal debt for 1997 below Dm54 billion ($32 billion). If Germany fails to achieve the Maastricht criteria for European economic and monetary union, the criteria may be disregarded or watered down. But at the same time, the German government is trying to reform other parts of the economy. Revamping the state pension scheme is one of the government’s chief concerns. It has traditionally operated on the principle that working generations pay for retirees’ pensions who benefit in a similar way when they reach retirement. Since there are no longer enough working people paying sufficient contributions to support the elderly, the government plans to increase contributions gradually over several years, while teaching Germans that they will have to start saving for private pensions. But the legal framework and tax breaks on new pension schemes have not yet been fixed. Stung by criticism that German companies are transferring jobs abroad because of punitive wage costs and high taxes, the government plans to reduce the top rate of individual taxation from 53% to 39%. Two corporate taxes may be scrapped altogether. But it faces opposition from the Social Democratic Party (SPD), which argues that lower tax revenues will create an additional budget deficit of Dm10 billion in 1998 alone. And the SPD’s support will be needed to get the plan through parliament. The state’s role in the economy grew after the integration of eastern Germany and, at more than 50% of GDP, has resisted most attempts to reduce it. The government has frozen federal budgets for 1997, but has little chance of restraining the federal states and municipalities. And economists like Lutz Hoffmann, president of the influential Deutsches Institut für Wirtschaftsforschung research institute, still find substantial support for their views that public spending should be increased. Hoffmann calls for an increase of at least Dm20 billion on public spending in 1998 to avoid recession. These disturbing economic realities and the lack of confidence in the government’s resolve could eventually raise borrowing costs for Germany, even if interest rates remain the same. Up to now, the influence and importance of the Bund market has rested on the strength of the German economy and of the Deutschmark. But after 2002, Germany will lose its currency and the nation’s weakened economy alone will be viewed by the markey as the main indicator of the value of German sovereign debt. In this environment, Germany’s chances of becoming the benchmark issuer of sovereign debt after monetary union look far less favourable than they were two or three years ago. Germany has grown accustomed to its pre-eminent position in Europe with the twin advantages of running both the largest economy and controlling Europe’s main reserve currency. It is still hard for the Germans to believe they will have to compete for that status after European monetary union. Meanwhile, the financial markets are waiting to hear whether and when the finance ministry will redenominate existing federal debt into euros. Deutschmark-debt issuers need to know this because they use the Bund as their benchmark, relying on the liquidity which only the Bund can offer. Furthermore, no German issuer can be certain that their euro-denominated debt will be on solid ground legally until the finance ministry has passed the appropriate legislation for Bunds. But like so many other pieces of legislation equally crucial to Germany’s economic and financial health, this bill is not making any real progress towards being passed into law. With so many reforms going on at once, issues that would normally be priorities have been delayed until later this year, or next year. And most of these are so important that negotiations have to be handled by the leading politicians in each of the coalition parties. German politicians hate to delegate. Restructuring the economy and meeting the Maastricht convergence criteria for monetary union make a dramatic reduction in state spending and borrowing necessary. Yet the Kohl government still seems to be hoping for some less painful compromises. Cynics say that the main impetus driving the government seems to be the urge to reach consensus within the centre-right coalition led by Helmut Kohl’s Christian Democratic Union. In most cases consensus has to be found with the opposition Social Democratic Party too, because it controls the upper house of parliament, the Bundesrat. Reforms are being stalled by disagreement within the ruling coalition about how far they need to go. The government says that the state’s role in the economy must be reduced for good. Meanwhile, influential voices like that of Klaus Zwickel, head of the IG Metall trade union, say that increased government spending is the only way to prevent the jobless queue lengthening to a total of five million people. Finance Minister Waigel had originally hoped to reduce the budget deficit to 2.5% of GDP by the end of this year. But as unemployment rises, he has been forced to amend this forecast to 2.9%. Meanwhile, economists at DB Research, the research arm of Deutsche Bank, believe that without a change in fiscal policy the federal budget shortfall will be around 3.3%. Already, the local capital market is begining to suffer as a result of these concerns. International investors and banks are deterred from doing business in a financial centre which needs more reform, but whose financiers have clearly not yet convinced their government that the financial sector is worth nurturing. Germany, and Frankfurt as its financial centre, are linked to the fortunes of the Deutschmark. But the Deutschmark capital market will probably exist for only two more years until liquidity in the European capital markets passes into the euro and that is the time available for Frankfurt to prove it can sustain life after the Deutschmark. Germany’s single greatest asset has always been the Deutschmark. By the time it disappears by 2002, the Frankfurt financial centre must learn to compete on its own merits. First, the German banks need to understand how their own situation is changing. So far, they have been favoured by their natural advantage in Deutschmark business. Up to now, German banks have been fortunate to maintain a strong underwriting business in this sector. They still dominate the Bund market and managed until last year to prevent any foreign banks from joining the inner circle of institutions which discusses the pricing and terms of new public-sector bond issues. They are also still favoured by local borrowers like DePfa, Kreditanstalt für Wiederaufbau, Landwirtschaftliche Rentenbank and DSL-Bank, which each borrow more than an equivalent of $10 billion every year, most of it in Deutschmarks. This advantage in Deutschmark business has sustained German banks which are still far stronger in underwriting for German issuers, in Deutschmark trading, and in sales to German investors than foreign banks. But it is brave indeed for any German bank to describe the business of its fixed-income division as “global markets”. Deutsche Morgan Grenfell is probably the exception. Its expansion into other national markets over the past two years has exhilarated the rest of German finance and prompted other German banks to respond. While Dresdner Kleinwort Benson also aspires to compete in the global markets, the others are concentrating on relationships with German issuers and investors. At most, they hope to remain specialists with certain financial instruments or to maintain their placing power in smaller markets like Austria and the Czech Republic. But as the European capital markets grow together, the long-standing ties between German banks and German clients are becoming weaker. L-Bank’s Deutschmark-French franc issue in January, the first parallel bond of its kind from any issuer, may prove to be a watershed. JP Morgan was chosen as underwriter because it had been the first to develop this new form of bond and was judged to have the greatest expertise. Now L-Bank is racing towards the euro-denominated market, it may never work with German banks in the same way again. The newly-formed Finanzplatz Association has the potential influence to successfully lobby the finance ministry in Bonn for further liberalization of the local capital market and to persuade the international investment community to do business with German institutions, in Germany. The Association says its ultimate aim is to improve the efficiency and standing of the local capital market and thus the strength of the German economy. But the members have differing interests and appear to have little idea how to go about this task. They are dawdling towards decisions about what they want, and how to achieve it. The Bundesbank has made numerous public statements urging the finance ministry to reduce public spending, encourage the business community by cutting taxes and give clear messages about its post-Emu debt conversion. But bankers still see the Bundesbank as a foot-dragger which maintains a muddled system of selling Bunds and refuses to join the bankers’ Finanzplatz lobbying association. That may be unfair, but the image persists nevertheless. Both the Bundesbank and the government appear to have grasped which challenges they face. But the Bundesbank is still confusing the market and the government is playing for time it does not have.
|
|||||||||||||||||||||||||||||||||||||
