US embassy cable - 04FRANKFURT9010

C O N F I D E N T I A L FRANKFURT 009010 
 
SIPDIS 
 
E.O. 12958: DECL: 10/18/2014 
TAGS: ECON, EFIN, ENRG, GM 
SUBJECT: BUNDESBANK CHEERS REFORMS BUT WORRIES WHETHER 
GOVERNMENT WILL TAKE NEEDED NEXT STEPS 
 
 
Classified By: Consul General Peter Bodde, reasons 1.4 (b) and (d) 
 
1. (C) SUMMARY.  Bundesbank analysts see tangible results 
coming out of the current labor-market reforms and a modest 
improvement in German competitiveness, but not enough to 
engineer a strong turnaround.  Further reforms are necessary, 
e.g., to expand the number of employed, but the Bundesbank 
fears the political will to proceed is weakening.  Germany 
can readily adjust to higher energy prices as long as 
supplies are assured.  The Bundesbank sees overall financial 
conditions in Germany as good -- with little current threat 
of inflation or deflation -- so the focus must remain on 
structural reforms.  END SUMMARY. 
 
2. (C) EMIN and Consulate rep called on Bundesbank Chief 
Economist Willy Friedmann, who opined that general financial 
conditions in Germany are good, including sustained low 
interest rates, but investment remains surprisingly weak. 
The Bundesbank does not/not agree with a recent OECD 
conclusion that German companies have high debt loads, since 
that study looked only at firms listed on stock exchanges and 
not SME's (Friedmann argues German companies overall have 
moderate debt-to-equity ratios which have flattened out since 
the end of the stock market boom).  Rather, Friedmann sees 
poor domestic consumer  confidence, high costs of doing 
business, and in particular, uncertainty over which reform 
initiatives politicians will approve and how far they will go 
as reasons for German companies' reluctance to invest at 
home.  The Bundesbank expects an increase in Germans' 
consumption spending in the coming year. 
 
3. (C) On economic reforms, Friedmann called the Government's 
Agenda 2010 a sound program, but one poorly marketed by 
policy-makers.  Friedmann expects the "Hartz IV" reforms 
(lowering payments to long-term unemployed) will lead to 
needed expanded employment in the low-wage sector in 2005. 
Bundesbank data already show more flexibility in labor 
markets.  He noted what other German economic analysts have 
suggested: that the long-term unemployed are going to have to 
move from the east to the western part of the country where 
there are better employment possibilities.  The tendency in 
German wages remains slightly downwards.  Friedmann voiced 
support for agreements reached within companies to expand 
working hours -- frequently with little or no pay increase -- 
and for the opposition's proposal to limit the rules 
protecting employees' jobs (Kundigungsschutz).  These factors 
should boost Germany's international competitiveness, 
especially if there is further growth in the German low wage 
sector.  Unfortunately, reform momentum is stalling.  Further 
tax reform is not on the horizon and Germany's main political 
parties still tend to espouse differing proposals (the right 
would lessen the burden on companies and investors, while the 
left has proposed to shift more of the tax burden onto 
wealthier Germans).  Pressure from outsourcing is becoming 
more intense:  a German Chamber of Industry and Trade  (DIHK) 
study shows that even medium-sized companies are considering 
moving production out of Germany.  Friedmann said German 
companies are raising money for their foreign investments 
outside Germany and that this explains why German statistics 
do not show large outflows of investment funds. 
 
4. (C) Asked about the potential impact of higher energy 
prices, Friedmann predicted "Germany can live with $40 
dollars per barrel" or even $50/barrel -- with only a limited 
impact on the country's economic outlook -- as long as supply 
is assured and demand forces are what pushes up energy 
prices.  Germany is now less dependent on oil than during 
previous price spikes, according to the Bundesbank's chief 
economist.  The current deceleration of world growth should 
ease demand pressure, and barring a true supply interruption, 
risk premiums and prices should fall.  Since low oil prices 
are probably a thing of the past, Friedmann said Germany and 
other oil-consuming countries will have to absorb a permanent 
negative shift in terms-of-trade. 
 
5. (C) Despite rising energy prices, the Bundesbank sees no 
significant inflationary pressures (meaning core inflation of 
0.5-1.0% excluding administrative price increases). 
Importantly, the risk of deflation has also subsided.  German 
industry has seen modest nominal wage increases this year and 
negative wage drift overall, meaning that Germany will likely 
enjoy a modest boost in competitiveness relative to other 
Euro-zone countries. 
BODDE