Euro Area Uncertainty Holds Back Stronger Recovery in Germany

Strong fundamentals underpin Germany’s role as anchor of stability in Europe

But uncertainty about euro area weighs significantly on German activity

Reviving growth in Germany tied to sustained reduction in this uncertainty

In spite of supportive domestic financial conditions and robust corporate balance sheets, a sharp slowdown last year and into early 2013 is mainly due to negative spillovers from recession in the euro area amplified by uncertainty about prospects and policies in the region.

“A stronger recovery in Germany hinges on a durable reduction of euro area uncertainty,” said Subir Lall, Assistant Director of the European Department, and the IMF’s mission chief for Germany. “In this sense, the circumstances for the German economy have changed. Last year Germany seemed relatively immune to developments in the rest of the euro area,” added Lall.

According to the IMF’s assessment of Europe’s largest economy, the rebound that started in 2010 gave way to weakening momentum during the course of 2012 when growth fell below potential. While exports to destinations outside Europe began to recover by mid-2012, exports to the rest of the euro area continued to decline as the deep recession in the region continued. Consumption remained a bright spot, buoyed by strong wage growth.

Drag on business investment

Financial stress in the euro area has abated, in part due to decisive and timely policy actions by major central banks. However, policy uncertainty at the euro area level is still perceived as high, and uncertainty in Germany is closely linked to that of the region.

This sensitivity of German businesses to euro area uncertainty is one of the most important reasons to postpone investment and adopt a wait-and-see attitude for many small and medium-sized enterprises despite easy financing conditions.

Looking ahead, “economic activity in Germany is expected to be weak in 2013,” emphasized Lall. The German economy is projected to expand at around 0.3 percent in 2013. A gradual pickup in activity projected towards the end of the year is conditional on a further and tangible reduction in this uncertainty and a gradual recovery in the rest of the euro area.

Deficit goals achieved

Against the backdrop of globalization, Germany has become increasingly sensitive to economic developments in the region and the rest of the world. An important source of risk is a possible re-emergence of financial stress in Europe, which could interact with already...