US embassy cable - 05FRANKFURT549

UNCLAS SECTION 01 OF 03 FRANKFURT 000549 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR EUR PDAS, EB, EUR/AGS, AND EUR/ERA 
STATE PASS FEDERAL RESERVE BOARD 
STATE PASS NSC 
TREASURY ALSO FOR ICN COX, HULL 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, EUN 
SUBJECT:  Germany's Economy Grows in 2004: Break Out the 
Beer, not the Champagne 
 
 
This cable is sensitive but unclassified.  Not/not for 
Internet distribution. 
 
1. (SBU) Summary:  Germany's Federal Statistical Office 
reported that Germany's economy grew 1.7% in real terms last 
year.  Even taking into account that 0.6 percentage points 
of that growth came from extra working days, the growth was 
higher than any experienced since 2000.  The cause for 
celebration is muted, however, as prospects for 2005 are 
uncertain.  The consensus forecast sees real growth of 
around 1.3 percent. 
 
2. (SBU) Growth in 2004 was driven by a positive trade 
balance.  The consensus assumption for 2005 is that lower 
positive net trade will not be compensated by a stronger 
pickup in domestic demand.  Previous forecasts have given 
weight to uncertainties in economic outlook and policy 
suppressing investment and private consumption.  Smooth 
implementation of recent reforms and plans for no major new 
initiatives in the coming year could remove some 
uncertainties and, together with growing industrial 
confidence, provide a surprise on the upside with higher 
growth than the consensus forecast of 1.3 percent in 2005. 
However, downside risks also loom, as unemployment and 
continued wage restraint will continue to weigh on personal 
consumption.  End Summary. 
 
------------------------------------- 
Good News:  Best Growth in Four Years 
------------------------------------- 
 
3. (SBU) The German Federal Statistical Office reported that 
real economic growth in Germany was 1.7 percent in 2004. 
This is the highest growth rate since 2000.  About one-third 
of the increase was due to "working day effects," as Germans 
worked 4.7 days more this year than last.  These extra 
working days occurred since scheduled holidays fell on 
weekends.  Economists tend to discount this effect. 
However, even the adjusted real growth rate of 1.1 percent 
is still the best in four years. 
 
--------------------------- 
Positive Side of the Ledger 
--------------------------- 
 
4. (SBU) Good news in 2004 was that export growth remained 
strong, with net trade contributing 1.2 percentage points to 
growth.  Enterprise profits rose 10.7 percent, the strongest 
jump since reunification.  Note that some of these profits 
accrued to the self-employed and small businesses as well as 
the large corporations.  Higher profits could be used to 
boost equipment and machinery investment.  Indeed, equipment 
investment showed the first signs of renewal in 2004, 
increasing a slight 1.2 percent after four years of decline. 
 
5. (SBU) Per capita unit labor wage costs fell by 1.3 
percent, strengthening Germany's export competitiveness. 
According to Goldman Sachs, wage restraint in recent years 
has counterbalanced the large increases after reunification, 
contributing to renewed German competitiveness in relation 
to France. 
 
---------------------------- 
The Other Side of the Ledger 
---------------------------- 
 
6. (SBU) Private consumption, which needs to rev up to drive 
domestic demand, contracted 0.3 percent, pulling down 
overall economic growth by 0.2 percentage points.  This is 
partially the flip side of wage restraint.  It also reflects 
high unemployment, low employment growth, and the tick up in 
savings rate.  Construction continued to drag down overall 
investment, but the slide of 2.5 percent was less that in 
the previous "bust" years that followed the construction 
boom. 
 
7. (SBU) The general government deficit was 3.9 percent of 
GDP, marking three years in a row that it has exceeded 3 
percent.  The government was pleased that the deficit did 
not hit the high mark it had budgeted.  Moreover, the 
statistical office has indicated that the numbers are likely 
to be revised which Finance Ministry officials claim will be 
downwards, with 3.7 percent as the final outturn.  More 
disturbing is that the federal government and social 
assurance programs accounted for 64 percent of the deficit, 
not 45 percent as Finance Minister Eichel had committed when 
he negotiated with the Federal States.  This may weaken his 
hand to instill fiscal discipline with the states in the 
future. 
 
------------------------------------------ 
And for the New Year - Steady as She Goes? 
------------------------------------------ 
 
8. (SBU) The German Government and European Commission 
forecast German real economic growth at 1.7 percent for 
2005.  The Commission, which had forecast 1.9 percent growth 
for 2004, reckoned that slower growth would be due to the 
absence of positive calendar effects.  In essence, a "steady 
as she goes" scenario. 
 
9. (SBU) A local private bank economist also sees no further 
increase, but uses for the base the adjusted growth figure 
of 1.1 percent growth that does not include the extra 
workdays.  The consensus forecast is for 1.3 percent real 
growth.  Our forecast for 2005 of last September puts us in 
the same camp as the Commission and the Government (Note: 
For the record we had forecast 1.8 percent for 2004). 
 
10. (SBU) The basic forecast scenario is that the net trade 
balance will reduce its contribution to growth as world 
trade slows, meaning that domestic demand will have to pick 
up the slack.  Key components of domestic demand are private 
consumption and investment.  The typical German recovery 
starts with exports, moves to investment, then jobs and 
consumption.  This formula failed to hold in 2004. 
Investment growth was soft until the end of the year.  If 
investment gathers more steam in 2005, which recent surveys 
suggest it might, then it would further confirm that the 
typical links in German recovery are still be in place, but 
with a time lag. 
 
--------------------------------------------- ----- 
2005: Downside Risks and Possible Upside Surprises 
--------------------------------------------- ----- 
 
11. (SBU) The tealeaves are more than muddy for discerning 
the outcome for 2005.  In our next forecast we will seek to 
distill their meaning.  A few thoughts, however, come to 
mind. 
 
12. (SBU) Downside risks continue to loom.  Continued wage 
restraint and high unemployment and modest employment gains 
suggest personal income increases will remain modest.  The 
savings rate has been increasing, reflecting (1) consumer 
anxieties over the economic outlook and how reforms will 
effect their pocketbooks; (2) higher profits of the self- 
employed; and (3) consumer recognition that future pensions 
can no longer count exclusively on the government pension 
system to maintain their current level but will need to be 
supplemented with private savings. 
 
13. (SBU) Still, there could be some surprises on the 
upside.  German Finance Ministry officials, while not 
purporting to be even guardedly optimistic, think that if 
there are no "negative shocks," 2005 could be a turnaround 
year. 
 
14. (SBU) Investment could improve from the baseline 
forecasts.  In December businessmen became more positive 
about the economic outlook, perhaps linked to oil price 
declines.  Corporates and banks seem to be emerging from 
their bouts of restructuring and are showing higher profits. 
The slowdown in the diminution of construction activity 
could continue (no growth would be a vast improvement over 
the steep declines of recent years). 
 
15. (SBU) Private consumption is a major question mark. 
Finance Ministry officials point out that the last phase of 
the income tax reform kicks in, reducing the top marginal 
rate to 42 percent.  While a smaller boost than previous 
cuts, at least as of January there do not appear to be 
increased charges by the social security system that would 
offset the tax breaks. 
 
16. (SBU) Consumers' confidence has been buffeted in recent 
years.  Noisy debates over reforms that affect the 
pocketbook (pension, labor, healthcare) and the uncertain 
course of economic policy placed an extra premium on 
caution.  So far, implementation of the labor market reforms 
has gone smoothly.  The government has opted not to take up 
further major reforms until after the 2006 elections, 
allowing the system to digest those already adopted. A 
senior Finance Ministry official, however, agreed that more 
reforms are needed and that Agenda 2010 should be seen as a 
process of reform rather than just a one-time reform 
package. 
 
17. (SBU) The European Commission presented a similar 
scenario in its autumn forecast for Germany.  It 
hypothesized that smooth implementation of the Hartz IV 
labor market reforms "will quickly dispel much of the 
uncertainty even of large parts of the population that are 
not immediately concerned by the reforms."  A more confident 
mood in Germany could do wonders. 
 
18. (U) This report coordinated with Embassy Berlin. 
 
19. (U) POC: James Wallar, Treasury Representative, e-mail 
wallarjg2@state.gov; tel. 49-(69)-7535-2431, fax 49-(69)- 
7535-2238 
 
Bodde