Scope Ratings AG today confirms the Federal Republic of Germany’s long-term local-currency issuer rating at AAA, following the release of its revised sovereign rating methodology, and converts its status from subscription to public. The agency also assigns a long-term foreign-currency issuer rating of AAA, along with a short-term issuer rating of S-1+ in both local and foreign currency. The sovereign’s senior unsecured debt in both local and foreign currency was also rated at AAA. All Outlooks are Stable.

Rating drivers

Germany’s AAA ratings are underpinned by the solid performance of its highly diversified economy – the largest in the euro area. Its robust, competitive economy has helped to keep public finance ratios under control and place them on a sound downward trajectory. Furthermore, fiscal policies aimed at balancing government budgets have generated an important consolidation track record. German government debt also benefits from German Bunds’ international 'safe haven' status, securing market access at moderate financing costs even in times of market turbulence.

German economic performance remains a key credit strength. The German economy has absorbed the shocks of the global financial crisis and the euro crisis. The world’s fourth-largest economy has a competitive high value-added manufacturing sector and an efficient labour market. Recent indicators suggest that the economic recovery will continue to pick up steam in 2017. The vigorous labour market, modest financing costs and buoyant construction activity are important drivers for growth and consumption. Moreover, in contrast to most euro-area countries, there is room for further public expenditure which will sustain the rate of economic growth. The German economy will also benefit from a strengthening global recovery, even though there is some downside risk due to Brexit negotiations and US trade policy uncertainties. Scope expects German real GDP to continue to grow by approximately 2% in 2017 and 2018.

The robust revenue generated by the German economy is sustained by an ongoing track record of current account surpluses of around 8% of GDP. Moreover, German corporations and households benefit from robust balance-sheet positions, leading to an advantageous net lending position on the macro level and helping to keep external debt at relatively moderate levels.

Germany’s fiscal policy approach is credit positive as it helps to keep budgetary risks in check. Fiscal discipline achieved constitutional status in 2009 and is clearly defined at sovereign and sub-sovereign level. The debt brake stipulates that the structural federal deficit must not exceed 0.35% of GDP as of 2016. From 2020, German Länder (federal states) will not be allowed to generate any structural deficits.

However, rising social transfers outweigh the savings gained from falling interest costs, leading to an increase in current government expenditure. Public consumption and investment linked to refugee-related expenditures is also expected to remain relatively high. While government revenue ratios remain fairly stable this will generate a decline in the government’s structural budget surplus to around 0.3% of GDP.

The general government debt-to-GDP ratio has dropped by nearly 10 percentage points over the past three years. Since the European sovereign debt crisis, Germany has continued to benefit from flight to quality, resulting in historically low refinancing costs. With ongoing budget surpluses and favourable growth and financing prospects, Scope expects the debt-to-GDP ratio to further decrease from 68.3% in 2016 to around 62% in 2018. The solid downward debt trajectory may lead to levels below 60% by 2020.

The German financial sector continues to grapple with rock-bottom interest rates, intense competition, crisis legacy issues and a high cost base, all of which dampen profits. Regulatory capital is generally comfortable, and the Bank Recovery and Resolution Directive (BRRD) limits the risks of contingent liabilities from the banking sector. Furthermore, Scope believes that German government finances would be able to absorb any adverse economic and financial shocks without compromising medium-term control of the debt trajectory.

Germany’s public-debt ratio has clearly benefitted from the country’s robust economic growth, strong government revenue generation and expenditure control, as well as extremely low financing costs. However, Scope sees medium- to long-term risks on the horizon, with population trends posing a major challenge.

Significant migration inflows due to the refugee crisis have sparked political, social and fiscal risk. Germany was faced with an influx of nearly 900,000 refugees in 2015 and 280,000 in 2016, creating challenges in terms of social and economic integration. Government expenditure to manage the influx and housing of refugees has a cyclical effect on the economy. However, levels of public spending which are unexpectedly high may put some pressure on public finances, whilst failure to properly integrate refugees into the labour market may lead to social and political risk. Important uncertainties persist. Despite the recent emergence of anti-establishment and populist political forces on Germany’s political landscape, Scope expects German political and economic consensus policies to continue unabated.

The ageing of German society is causing a significant decline in the working-age population, raising substantial uncertainties around Germany’s medium- to long-term economic growth potential. Together with increasing unfunded pension liabilities, this situation may jeopardise the long-term sustainability of public finances. The demographic trend is likely to boost age-related spending and dampen government revenue generation on the back of weaker economic growth. Further adjustments in the social security and pension systems will be necessary. Scope believes that addressing these issues and achieving consensus on reforms with an aging electorate will prove challenging for the government.

The sovereign rating scorecard (CVS) and qualitative scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides an indicative AAA (aaa) rating range for the German sovereign. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the extent of relative credit strengths or weaknesses as compared to peers, based on Scope analysts’ qualitative findings. For Germany, relative credit strengths have been identified for the following analytical categories: i) growth potential for the economy; ii) market access and funding sources for the sovereign; iii) external economic risk and iv) political risk. A relative credit weakness has been identified for financial stability. Combined CVS and QS analysis indicate a sovereign rating of AAA for Germany.

The results have been discussed and confirmed by a rating committee.

For further details, please see Appendix 2 of the rating report.

Outlook and rating-change drivers

Scope’s AAA sovereign rating for Germany is a reflection of its strong economic, fiscal and public-debt track record. As a consequence, only a very substantial deterioration in economic, fiscal and public-debt trends would exert pressure on the rating.

For the detailed research report please click HERE.

Rating committee

The main points discussed during the rating committee were: (1) economic growth potential and outlook, (2) soundness of public finance, (3) external economic position, (4) financial and banking sector performance, (5) latest political developments, (6) ageing population pressures and structural reforms agenda, (7) peers consideration.

Methodology

The methodology applicable for this rating and/or rating outlook “Public Finance Sovereign Ratings” is available on www.scoperatings.com.

Historical default rates of Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/governance-and-policies/regulatory/esma-registration. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default, definitions of rating notations can be found in Scope’s public Credit Rating methodologies on www.scoperatings.com.

The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months. A rating change is, however, not automatically ensured.

Regulatory disclosures

This credit rating and/or rating outlook is issued by Scope Ratings AG.
Rating prepared by Dr Giacomo Barisone, Lead Analyst
Person responsible for approval of the rating Dr Stefan Bund, Chief Analytical Officer
The ratings /outlook was first assigned by Scope as subscription rating on January 2003. The subscription ratings/outlooks were last updated on 05.05.2017.
The senior unsecured debt ratings as well as the short term issuer ratings were assigned by Scope for the first time.
As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on Federal Republic of Germany are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Sovereign Ratings Calendar of 2017" published on 30.06.2017 on www.scoperatings .com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case the deviation was due to the recent revision of Scope’s Sovereign Rating Methodology and the subsequent putting the ratings under review, in order to conclude the review and disclose these ratings in a timely manner, as required by the Article 10(1) of the CRA Regulation¹.

¹Editor's note: The above paragraph was corrected on 17 July 2017 following the publication of the credit rating action on 30 June 2017. The original wording was: Deviation of the publication of sovereign ratings or related rating outlooks from the calendar shall only be possible where necessary for the credit rating agency to comply with its obligations under Article 8(2), Article 10(1) and Article 11(1) and shall be accompanied by a detailed explanation of the reasons for the deviation from the announced calendar. It was replaced with the following: As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on Federal Republic of Germany are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Sovereign Ratings Calendar of 2017" published on 30.06.2017 on www.scoperatings .com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case the deviation was due to the recent revision of Scope’s Sovereign Rating Methodology and the subsequent putting the ratings under review, in order to conclude the review and disclose these ratings in a timely manner, as required by the Article 10(1) of the CRA Regulation.

Solicitation, key sources and quality of information
The rating was initiated by Scope and was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.
The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: the Ministry of Finance, Deutsche Bundesbank, Deutsche Finanzagentur, Federal Statistical Office, Stability Council, Eurostat, European Commission, IMF, OECD, and Haver Analytics.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Conditions of use / exclusion of liability
© 2017 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings AG, Scope Analysis, Scope Investor Services GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope cannot, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided “as is” without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or otherwise damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party, as opinions on relative credit risk and not as a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings AG at Lennéstraße 5 D-10785 Berlin.

Scope Ratings AG, Lennéstrasse 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 161306, Executive Board: Torsten Hinrichs (CEO), Dr. Stefan Bund; Chair of the supervisory board: Dr. Martha Boeckenfeld.