Ukraine war dampens investment

QI-2022 QUARTERLY REPORT GERMANY

Ukraine war dampens investment Economic uncertainty jeopardises recovery in 2022

▪

Ukraine war dampens economic expectations and investment propensity across industrial sector. Investment in plant and equipment likely to stagnate in 2022.

▪

A disruption of Russian gas imports would unleash complex domino effects, disrupting production in many industries.

▪

High energy prices generate losses in purchasing power, only marginal increase in private consumption spending anticipated.

▪

Foreign trade will also keep growth down. Value of imports is currently rising substantially, while growth in exports is faltering. Greatly increased commodity and energy prices are causing surge in imports, while German exports struggle with lower global growth and sanctions.

▪

Grim outlook. With uncertainties looming large, we cannot forecast economic development going forward at present. Real economic output increased by 2.9 percent last year. Industrial production rose four percent. Companies can only work off a proportion of their full order books due to sustained supply chain problems. New bottlenecks arise, situation will remain difficult.

▪

Sharp drop in ifo business climate index indicates uncertainty in business sector. Drop in sentiment has only been bigger in the first months of Covid in March and April 2020. Prospects for the next six months even registered biggest drop ever.

Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

Content German economy ................................................................................................................................ 3 Fourth wave of pandemic curbs fourth quarter growth ......................................................................... 3 Foreign trade records growth spurt in fourth quarter ............................................................................ 4 Labour market: employment continues to grow .................................................................................... 5 Incoming orders continue to swell after turn of year ............................................................................. 6 Industrial production still below pre-pandemic levels two years on ...................................................... 8 Capacity utilisation picks up slightly at beginning of year ................................................................... 10 Sales below pre-pandemic level in fourth quarter 2021 ...................................................................... 10 Ukraine crisis likely to derail industrial economic recovery ................................................................. 11 Ukraine war causes business sentiment to cave in ............................................................................ 11 Outlook ............................................................................................................................................... 12 The consequences of war and their assessment ................................................................................ 13 Proceeding with caution ...................................................................................................................... 14 Economic policy measures to mitigate damage to the business sector ............................................. 14 Sources .............................................................................................................................................. 16 Imprint ................................................................................................................................................ 16 Basic data for national accounts ..................................................................................................... 17

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

German economy Fourth wave of pandemic curbs fourth quarter growth Germany’s fourth Covid wave took the wind out of economic recovery at the end of 2021. According to German Federal Statistical Office figures, Germany’s gross domestic product declined 0.3 percent in the fourth quarter 2021 compared to the previous quarter following price, calendar and seasonal adjustment, after expanding 1.7 percent in the third quarter. Year on year, real economic output was up by 1.8 percent in the fourth quarter, following an increase of 2.8 percent in the third quarter. Compared to the figures published in late January (minus 0.7 percent), the drop in GDP was actually much lower. Annual GDP growth in 2021 was also slightly higher, at 2.9 percent. Germany’s economic output in the fourth quarter 2021 was generated by a workforce of 45.4 million. That is 434,000 more than one year ago.

On the output side of GDP, gross value added grew by two percent in the fourth quarter 2021 year on year in real terms. Corporate service providers and other service providers contributed strongly to growth, with gross value added here up by 7.7 percent and 5.5 percent respectively year on year.

Above-average growth was also registered in retail, transport, and hospitality (up 3.9 percent), information and communications (up 3.8 percent), and in education and healthcare (up 3.3 percent).

Financial and insurance services expanded slightly (up 1.4 percent) as did real estate (up 0.8 percent).

Gross value added in manufacturing dropped by 1.7 percent and in construction by as much as 3.1 percent following robust growth over the six summer months.

On the expenditure side of GDP, consumption expenditure of private households in the fourth quarter 2021 was up 2.6 percent year on year in real terms, but still 3.8 percent below pre-pandemic levels after seasonal and calendar adjustment. Consumers spent more on clothing and shoes (up 13.4 percent) and on leisure, entertainment, and culture (up 7.6 percent). Spending on hotels and restaurants was 60 percent higher due to the slump here last year. On the other hand, households spent slightly less than in 2020 on home furnishings and household goods and on food, beverages, and tobacco. Expenditure on housing, energy and heating was up narrowly in real terms (up 0.4 percent). State consumption expenditure rose another 2.6 percent in the final quarter of the year. Following seasonal and calendar adjustment, state consumption expenditure was 6.2 percent higher than before the pandemic.

Gross fixed capital formation contracted by 1.5 percent in the fourth quarter. While investment in plant and equipment dropped 2.6 percent and construction investment 1.6 percent, investment in other assets (including software and patents) was up by a slim 0.8 percent in the fourth quarter. High momentum in inventories resulted in a positive contribution to growth of 1.4 percentage points. Overall, gross fixed capital formation increased GDP growth by one percentage point. Exports increased by 8.2 percent compared to the previous quarter in real terms. The steep rise in exported services of 20.3 percent dwarfed the increase in exported goods of 5.5 percent. In the same period, imports were up 12.2 percent. While the import of goods rose by only 6.6 percent, the import of services expanded by more than one third. The large rise in imports turned net exports negative, bringing GDP growth down by one percentage point.

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

Growth in real GDP in percent 12 10 8 6

2.7

4

1.1

2.9

1.1

2 0 -2 -4 -6

-4.6

-8 -10 -12 I

II

III

IV

I

2017

II

III

2018

IV

I

II

III

2019

IV

I

II

III

2020

IV

I

II

III

IV

2021

change over previous year quarter change over previous quarter change over previous year Source: Federal Statistical Office

Foreign trade records growth spurt in fourth quarter German foreign trade speeded up further at the end of the year. Goods exports increased by 11.9 percent in the fourth quarter compared to the fourth quarter 2021 (country-specific seasonally adjusted data is not available). The strongest growth by far in absolute terms was in exports to the Netherlands (up 5.1 billion euros or 22.7 percent) and in exports to the United States (up 4.05 billion euros or 14.3 percent). Exports to Italy and Austria also increased by more than one fifth and more than three billion euros in each case. Double digit growth was also recorded in exports destined for Germany’s neighbouring countries France, Poland, Switzerland, the Czech Republic and Belgium. In contrast, exports to China dipped 480 million euros or 1.8 percent. Goods exported to Turkey were 15.6 percent down in value. Exports to the United Kingdom decreased by 1.47 billion euros or eight percent.

Goods imported to Germany in the fourth quarter 2021 rose 21.7 percent compared to the fourth quarter 2021, growing almost twice as much as exported goods. The strongest growth in absolute terms was in imports from China (up 10.53 billion euros or 33.4 percent), followed by imports from the Netherlands (up 8.79 billion euros or 39.1 percent) and Belgium (up 4.24 billion euros or 43.6 percent).

The price surge in energy commodities inflated the value of imports from supplier countries with imports from Russia up 74.2 percent and Norway up 364 percent. Double digit growth was also recorded in imports from Germany’s neighbouring countries France, Poland and Austria, and from Italy. Imports from Mexico and the United Kingdom swam against the tide, shrinking 23.8 percent and 10.1 percent respectively.

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

German exports and imports in Q4 2021 in selected countries Year-on-year change increase (+) or decrease (-) in exports in million euros

increase (+) or decrease (-) in imports

in %

in million euros

in %

Netherlands

27 423

+ 5 104

+

22.9

China

42 052

+ 10 543

+

33.4

USA

32 622

+ 4 055

+

14.2

Netherlands

31 275

+ 8 791

+

39.1

Italy

20 357

+ 3 875

+

23.5

Norway

9 432

+ 7 397

+ 363.5

Austria

19 184

+ 3 406

+

21.6

Belgium

13 975

+ 4 244

+

43.6

France

26 725

+ 2 688

+

11.2

Russia

9 869

+ 4 202

+

74.2

Poland

20 778

+ 2 664

+

14.7

Italy

17 320

+ 2 507

+

16.9

Switzerland

16 426

+ 2 429

+

17.3

Austria

12 712

+ 1 935

+

18.0

Czech Republic

12 684

+ 1 997

+

18.7

Poland

18 547

+ 1 718

+

10.2

Belgium

13 215

+ 1 391

+

11.8

France

17 014

+ 1 581

+

10.2

Russia

7 107

+ 1 199

+

20.3

USA

18 673

+ 1 459

+

8.5

Spain

11 166

+

935

+

9.1

Spain

9 524

+ 1 077

+

12.7

7 487

+

860

+

13.0

Taiwan

3 452

+

980

+

39.7

12 610

+

905

+

7.7

Mexico

1 887

-

589

-

23.8

Great Britain

8 331

-

932

-

10.1

Hungary

Switzerland China

26 748

-

483

-

1.8

Turkey

5 339

-

990

-

15.6

16 825

- 1 466

-

8.0

364 194

+ 38 710

+

11.9

Great Britain Total

Total

333 281

+ 59 349

+ 21.7

Sources: Federal Statistical Office, own calculations

Labour market: employment continues to grow According to preliminary data from the German Federal Statistical Office, the number of people in employment rose by 80,000 in January 2022 following seasonal adjustment, after rising 56,000 in December 2021. Compared to January 2021, the number of people in employment was up by 636,000 or 1.4 percent to a total of 45.06 million.

The latest figures also show an increase in employment subject to social security contributions.

According to the latest projections of the Federal Employment Agency, a total of 34.3 million people

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

were in employment subject to social security contributions in December 2021 (most recent figure available). That is 82,000 people more than in November, after seasonal adjustment, and as much as 603,000 more than in December 2020. The number of workers in full-time employment subject to social security contributions increased by 318,000 or 1.3 percent year on year. The number of workers in part-time employment subject to social security contributions rose by 286,000 or 2.9 percent.

Other forms of employment decreased according to the latest figures. The number of self-employed people including contributing family members recorded another slight drop in the fourth quarter 2021 compared to the third quarter. Compared to the fourth quarter in the previous year, self-employment was down by 69,000 or 1.7 percent to 3.91 million. The number of people exclusively in marginal employment also nudged down further, dropping 9,000 or 0.2 percent in December 2021 year on year down to 4.11 million, according to preliminary figures from the Federal Employment Agency. The number of unemployed people decreased by 476,000 or 16.4 percent to 2.43 million in February 2022 (year on year). The unemployment rate in February 2022 was at five percent as calculated by the Federal Employment Agency, or three percent according to the ILO definition.

German labour market* 4 34 Unemployed persons (right axis) 3

32

2 Employed persons covered by social security (left axis) 1

30 0

28

2014 2012

2015 2013

2016 2014

2017 2015

2018 2016

2019 2017

2020

2021

2 2022

-1

Difference in the number of workers making social security contributions from the same month last year (right axis) *seasonally adjusted in million Source: Federal Employment Agency

Incoming orders continue to swell after turn of year In January 2022, incoming orders for German industry were 1.8 percent higher than in the previous month following price, calendar and seasonal adjustment. While domestic orders dropped by 8.3 percent, foreign orders spiked the other way, growing 9.4 percent. Demand from third countries surged 17 percent while orders from the euro area dropped 2.6 percent.

Following a revision of the December figures, new orders dropped 4.2 percent compared to the third quarter after seasonal and calendar adjustment. This was the first drop in new orders in five quarters, since summer 2020. Year on year, incoming orders continued their upward trend, rising 2.8 percent.

Looking at the origin of orders in the fourth quarter, domestic orders were 3.7 percent up year on year, clearly outperforming foreign orders, which were up by 2.1 percent. Foreign orders showed divergent

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

trends though, with demand from the euro area increasing by 5.6 percent and orders from third countries slipping down 0.1 percent.

Among the main groups of industrial goods, demand for consumer goods experienced the strongest growth, rising eight percent year on year. Demand from within Germany and abroad expanded at a similar pace. Capital goods producers received 2.8 percent more orders, mostly domestic orders, which increased by 7.6 percent, while demand from abroad stagnated with a marginal plus of 0.3 percent.

Producers of intermediates recorded the lowest rise in incoming orders, with an increase of only 1.5 percent and orders from abroad rising by 4.2 percent while domestic orders dropped by a narrow 1.2 percent.

New orders, manufacturing 120

75

115

65

110

55

105

45

100

35

95

25

90

3.2

85

15

5.0

1.2

5

80

-5 -4.2

75

-15

70

-25

65

-35 2018

2019

2020

2021

2022

Change over previous year, two-month-average, in percent (right axis) Volume index in manufacturing, two-month-average, seasonally adjusted (left axis) Change over previous quarter (q-o-q), in percent Source: Federal Statistical Office

German industry recorded a strong increase in incoming orders at the end of the second year of Covid.

As supply chain problems continue to hamper production, companies will be unable to complete all these orders and their backlog will grow. According to figures from the ifo Institute, the reach of orders in hand in manufacturing hit a new record high for the third consecutive time at the beginning of the first quarter 2022, rising to 4.5 months. Capital goods producers accounted for the high increase in the reach of orders in hand. Their order books are continuing to swell with orders in hand at 6.4 months, surpassing the all-time high so far of 5.7 months recorded in October 2021. Capital goods producers thus have 2.7 more production months’ worth of new orders in their books than on average over the past ten years. The backlog for producers of intermediates stagnated at its current all-time high, with 3.7 production months’ worth of orders on their books. Consumer goods also managed to work off their orders with the reach of uncompleted orders stagnating at 2.2 months, only slightly above the longterm average.

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

According to figures from the German Federal Statistical Office, which have published this data series since 2015, the orders in hand in manufacturing in December 2021 were up in November 2021 by 1.5 percent, following price, seasonal and calendar adjustment. Incoming orders for manufacturing have increased continually since June 2020 and, at the end of 2021, were at their highest level since the data series restarted. The backlog of orders was 29.3 percent higher following seasonal and calendar adjustment than in February 2020, the month before restrictions were imposed to stem the spread of the pandemic. The backlog of orders from at home increased by three percent in December, making it 36.6 percent higher than in February 2020. The backlog of foreign orders increased by 0.8 percent, bringing it to 25.9 percent above the pre-pandemic level.

Industrial production still below pre-pandemic levels two years on In January 2022, industrial production rose 1.3 percent over the previous month following seasonal and calendar adjustment, according to preliminary figures. Production growth for December 2021 was upwardly revised to 2.1 percent (formerly: up 1.2 percent). Construction also increased production robustly thanks to the mild weather this January, rising 12.5 percent year on year.

Mainstream construction and the finishing trades accelerated production at a simil ar rate. The energy industry, in contrast, reduced its output compared to the previous month by a marginal 0.1 percent. Overall, total production output was 2.7 percent higher than in December 2021 and 1.8 percent higher than in the same month last year.

In the fourth quarter 2021, industrial output increased by 2.2 percent over the previous quarter following seasonal and calendar adjustment. This marks the end of the downward trend which set in at the beginning of last year. Compared to the previous year, however, production was down 1.6 percent. Energy production increased by 2.5 percent over the previous quarter following seasonal and calendar adjustment. Year on year, energy production was up by two percent. In construction, production decreased both compared to the previous quarter (down one percent) and compared to the same period last year (down 4.6 percent). The main factor pushing production down in construction was the weak performance of the finishing trades. Mainstream construction expanded its activity both compared to the previous quarter (up 0.9 percent) and compared to the previous year (up 1.7 percent). Among the main industrial groups, the producers of intermediates produced 0.1 percent less than in the third quarter 2021 but drew level year on year. Capital goods producers managed to increase production by five percent compared to the previous quarter but came in at minus 5.1 percent year on year. Consumer goods producers kept production almost steady at third quarter levels (down 0.1 percent) and recorded an increase of three percent year on year.

Now in the second year following the outbreak of the pandemic, industry has still not fully recovered.

Compared to the pre-pandemic year of 2019, manufacturing output is still down by more than six percent, and as much as 30 percent in vehicle production. Some industries have nonetheless completely recovered from the Covid shock, including the electrical and electronics industry, chemicals and pharmaceuticals.

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

Production development in the manufacturing industry year on year change in percent 2020 2021 2021 year Q2 Q3 Q4 original value calendar adjusted

compared to previous period in percent 2021 2022 Q2 Q3 Q4 Nov Dec Jan seasonally and calendar adjusted

Production

- 7.3

3.2

15.9

2.2

- 2.0

- 0.5

- 2.3

1.5

0.3

1.1

2.7

Industry

- 9.6

4.3

19.7

2.5

- 1.6

- 1.2

- 2.3

2.2

0.5

2.1

1.3

Intermediat goods

- 6.1

7.7

22.4

7.9

0.2

0.8

- 2.3

- 0.1

0.8

1.3

0.3

- 14.6

1.8

22.8

- 2.7

- 5.1

- 4.0

- 4.0

5.0

- 0.1

4.4

1.2

Consumer goods

- 3.7

2.7

7.6

3.6

3.0

1.1

1.6

- 0.1

1.4

- 0.7

4.0

Energy

- 6.1

2.7

11.9

2.2

2.0

2.5

- 1.1

2.5

- 0.8

0.5

- 0.1

Construction industry

4.2

- 1.2

2.0

0.8

- 4.6

2.6

- 2.5

- 1.0

- 0.3

- 4.0

10.1

Construction industry proper

5.4

0.9

2.5

1.1

1.7

2.7

- 1.6

0.9

0.2

- 3.0

6.3

Finishing industry

3.1

- 3.3

1.5

0.4

- 9.2

2.6

- 3.4

- 2.9

- 0.7

- 5.0

14.2

Capital goods

Sources: Federal Statistical Office, own calculations

Production, manufacturing 110

40 30

100

20

2.2

90

3.0

10 0

-1.2

-2.3 -10

80

-20 70

-30 2018

2019

2020

2021

2022

Change over previous year, two-month-comparison, in percent (right axis) Volume index in manufacturing, two-month-average, seasonally adjusted (left axis) Change over previous quarter (q-o-q), in percent Source: Federal Statistical Office

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

Capacity utilisation picks up slightly at beginning of year Industrial capacity utilisation further increased at the beginning of 2022. According to figures from the ifo Institute, capacity utilisation in manufacturing was at 85.6 percent at the beginning of the first quarter. This corresponds to an increase in capacity utilisation of 0.7 percentage points compared to the previous quarter. At the same time, capacity utilisation was 1.5 percent higher than on average over the last ten years. Capacity utilisation in manufacturing excluding food only increased by 0.6 percentage points, but, at 86 percent, was also 1.5 percentage points above the ten-year average.

The trends in the individual industries were very divergent. Capacity utilisation in vehicle production increased the most, according to the latest figures, but, at 84.1 percent, was still 2.3 percent below the long-term average. Capacity utilisation among producers of data processing equipment and optical and electronic devices dropped slightly but was still well over the long-term average. In metalworking, capacity utilisation dropped 0.9 percentage points to 79.3 percent. In machinery manufacturing, capacity utilisation was at 89.5 percent which is well above both the pre-pandemic level and the longterm average. Textiles and furniture recorded a downturn in capacity utilisation. In the pharmaceutical industry, the most recent figures show a sharp rise in capacity utilisation though it is still well below the long-term average.

Sales below pre-pandemic level in fourth quarter 2021 While fourth-quarter sales in the manufacturing sector increased compared to the previous quarter, sales were down by 0.6 percent year on year with domestic sales 2.2 percent lower and foreign sales 0.9 percent higher. In 2021 overall, sales were up 10.2 percent. The increase in sales from at home of 8.4 percent was lower than in sales from abroad (up 12.1 percent).

Manufacturing revenue* from January till December 2021 Wood processing

22.0

Metal production and metalworking sector

20.4

Chemical industry

19.8

Electronic industry

14.9

Pharmaceuticals

14.4

Paper and pape

13.2

Glass, ceramics, stone, industrial minerals

9.2

Motor vehicle production

8.5

Machinery manufacturing

7.1

Textiles, fasion, leather

7.0

Food, beverages, tobacco Print industry Other transport equipment production

0.1 -1.4 -2.0

*Change in percent, year on year Source: Federal Statistical Office

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

Among the individual industries, the strongest growth in sales for the year overall was recorded by the timber industry (up 22 percent), metal production and metalworking (up 20.4 percent), and in chemicals (up 19.8 percent). The electrical and electronics industry, the paper industry and pharmaceuticals also all recorded double-digit growth in annual sales. High single-digit growth in sales was reported by the building materials industry, vehicle and machinery manufacturing, and the textiles and clothing industry. Sales in the food, drinks, and tobacco industry stagnated while sales were down in the print industry by 1.4 percent and in other transport equipment by two percent.

Ukraine crisis likely to derail industrial economic recovery Manufacturing started out the year with a small positive carry-over effect due to its strong performance in the first six months and sideways trend in the second half of last year. If production levels remain at their fourth quarter 2021 levels in 2022, pr oduction would increase by 0.1 percent in the year overall. The carryover effect for capital goods production was slightly higher, at 0.5 percent, and, for consumer goods production at one percent. The production of intermediates would go down (down 1.1 percent).

The purchasing managers’ index for manufacturing declined slightly in March 2022, but, at 57.6, it is still well above the 50-point threshold indicating expansion. It has become very questionable whether expansion will actually take place. The outbreak of the military conflict in Ukraine will, in all likelihood, not only exacerbate supply chain problems but also lead to considerable disruptions in production the impact of which can not be gauged at present.

Ukraine war causes business sentiment to cave in Sentiment in German industry deteriorated dramatically in March 2022 in response to the Russian invasion of Ukraine. The ifo business climate index plunged down 7.7 index points, its biggest fall ever apart from March and April 2020. While the majority of companies surveyed were only slightly less optimistic about their current business situation, prospects for the next six months fell more steeply than ever before. Among the individual sectors, the drop in sentiment was most pronounced in wholesale and retail. Retailers continued to be satisfied with current business, but prospects caved in at record speed. Sentiment among service providers has also clouded over considerably. Although service providers rated current business as slightly better than in February, here too, prospects plunged. Logistics providers were particularly concerned about the future. The climate index in mainstream construction also dropped substantially. While most of the construction companies surveyed continued to assess their current business as positive, business prospects in this sector have fallen lower than at the start of the Covid pandemic in 2020. The mood in manufacturing has turned around completely. The prospects indicator tumbled down 19.8 index points which is almost twice as much as in spring 2020. From fairly optimistic, prospects have switched firmly into the negative. Companies were also less positive about current busi ness than they were in February. Export prospects have also turned around, going from a positive 17 points down to minus 2.3 points, the biggest drop recorded apart from at the beginning of the Covid crisis.

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

ifo Business-Cycle Clock German manufacturing*

30 Boom

Business expectations for the next six month

Upswing Jan 2021

20 10

Jan 2018

Jan 2022

Jan 2017

0 Jan 2020

Jan 2019

-10 -20

March 2022

-30 -40 -50 Reccession

Downswing

-60 -60

-50

-40

*Balances seasonally adjusted

-30

-20

-10

0

10

20

30

40

50

60

Assesment of current business situation

Source: ifo Institut

Outlook At the beginning of spring, some restrictions imposed to stem the pandemic in Germany were eased or even lifted. The easing of restrictions alone could have accelerated the economic recovery on the cards for spring if the upturn had not ended abruptly with the outbreak of the war between Russia and Ukraine.

At the start of the year, we anticipated a robust increase in the export of goods and services, but several factors have thwarted this development. The lower level of global growth now anticipated will already dampen the global demand for German products. The OECD (2022) is expecting global economic activity to drop by a good one percentage point which will naturally have a greater impact on Europe than on the United States or East Asia. The main factor burdening German foreign trade is the lower growth prospects of Germany’s EU partners. On the supply side, bottlenecks have still not been resolved and are now being exacerbated by European Union embargo measures and renewed restrictions imposed in the People’s Republic of China to stem the resurgence of Covid. Even if foreign demand remains adequate, the current obstacles to supplies and production will hinder orders from being completed. Regarding imports, lower production levels will also reduce demand for intermediates. The steep price increases for energy and non-energy commodities will further deteriorate the terms of trade and inflate the cost of imports. All in all, these developments are likely to result in a negative trade balance which will reduce GDP growth.

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

The easing of restrictions has increased the prospects for rising employment, particularly in services.

The reduction in short-time work, the planned increase in the statutory minimum wage and the high level of savings carried over from last year would all work towards increasing the consumption expenditure of private households but the sharp increase in energy and food prices are likely to cancel out this effect, lead to a considerable loss of purchasing power and dampen consumer demand. State consumption expenditure is, on the other hand, likely to expand on account of the support expected to be provided to refugees from Ukraine and the foreseeable support measures of the federal government to compensate war-related costs. Overall, we expect consumption expenditure to make a small contribution to growth.

Investment activity is likely to be restrained this year despite the investment necessary to unfold the digital and energy transformation. The latest issue of ECB’s quarterly Bank Leading Survey released in early February pointed to a clear increase in the demand for corporate lending as a sign for a pickup in investment. The heightened uncertainties on account of the war between Russia and Ukraine is highly likely to make investors reticent to invest, especially as the most recent figures show a dramatic deterioration in export prospects. This will stifle momentum in investment in plant and equipment.

The high demand for residential housing and the continuing favourable financing conditions should make for a stable development in residential construction, which accounts for the bulk of construction investment. Regarding commercial construction, the number of building permits increased last year although it remains uncertain how many of these buildings will be built. Alongside the reticent of investors on account of the war, an increase in mobile working is reducing demand for office and administrative buildings. Commercial civil engineering looks solid. In addition to the expansion of the rail network by Deutsche Bahn AG, many utility providers are planning investment in renewable energies and grid expansion. In public construction, the teething problems of the federal government company Autobahn GmbH should have been overcome by now, opening the way for funds to be spent on the new construction and expansion of the motorway network. We expect investment in other assets (software, research and development) to record low real growth as in the previous two years. All in all, gross fixed capital formation is only likely to contribute to growth on a low level.

The consequences of war and their assessment The repercussions of the war in Ukraine will place considerable strain on German GDP growth this year. The ECB recently estimated the possible cut in growth for the euro area, quantifying the impact at between minus 0.5 and minus 1.9 percentage points. However, these estimates do not factor in additional financial policy measures taken by governments (ECB 2022). The OECD (OECD 2022) has also estimated the impact developments on the commodity and financial markets seen since the beginning of the war will have on global GDP if the military conflict continues. Continued military conflict, according to its calculations, would reduce global GDP growth in the current year by more than one percentage point and increase global inflation by 2.5 percentage points. European economies would be the most affected, alongside Russia and Ukraine. Growth in the euro area would be 1.3 percentage points lower with an increase in prices of two percentage points.

On account of the high degree of uncertainty regarding the further course of the war and the impact on global markets, we will refrain from making predictions in the context of various scenarios at this point in time. A disruption in gas imports from Russia could, in particular, trigger complex cascade effects disrupting production in numerous industries the macroeconomic impact of which cannot be adequately modelled (see, e.g., Bachmann et al. 2022 and DIW 2022, and for estimates, IMK 2022).

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

In our opinion, quantifying the possible negative impact on overall economic output at between one half of a percentage point and three percentage points is a considerable underestimate of the full impact on production disruptions in the event that intermediates become scarce.

Surveys carried out by the German Economic Institute (IW) also show that a very high proportion of companies in almost all industries and industry-related services are affected not only by higher energy supply prices, but also by the supply of gas and a shortage of intermediates (IW 2022). Initial analyses of a suspension of energy supplies indicate the complex consequences this would have and the range of possible responses available to industry and the public sector in the EU (Bruegel 2022).

The ifo Institute (ifo 2022) has downwardly revised its growth forecast for the current year to 3.1 percent based on the assumption that commodity prices have already peaked and will gradually decrease over the coming months. An alternative scenario analysed by ifo in which energy prices only peak in the middle of 2022 would stunt GDP growth further, bringing it down to 2.2 percent and the increase in prices up to 6.1 percent.

In its spring update, the German Council of Economic Experts (GCEE) slashed its growth forecast for real economic output in Germany to 1.8 percent this year and 3.6 percent for 2023 (GCEE 2022); for the euro area the GCEE stuck to its forecast of 2.9 percent growth in both years. The GCEE also still believes that the global economy will grow 3.3 percent this year (3.1 percent in 2023), with an expansion in global trade of 1.8 percent (3.1 percent in 2023).

Proceeding with caution While it is still somewhat too early to reliably quantify the impact of the war, it will undoubtedly weaken global growth and impede economic recovery in the euro area. Foreign trade and investment activity will also be negatively affected. On account of a lack of historical experience, it is unsure whether and to what extent this uncertainty will affect the purchasing decisions of private households. The extent to which companies will postpone or cancel investments is also far from clear. The financial policy response is also still being developed. The coalition government has already approved the relief packages I and II containing a mix of measures designed to reduce the burden particularly on low and medium-income citizens. The volume of the packages amounts to just over 30 billion euros in additional expenditure and relief. Major increases in defence expenditure have also been decided although the volume to be spent this year is still not clear. Additional measures to support companies that are particularly hard hit have already been announced, including a German Development Bank scheme presented by Federal Minister Habeck. These are all signs that financial policy will try to counteract the negative impact of the war.

At the same time, a further escalation of the conflict could also raise further economic problems which cannot all be addressed with short-term measures. The risk of serious disruptions in energy supplies, global transport logistics and industrial production in European countries is likely to remain considerably high for some time to come.

Economic policy measures to mitigate damage to the business sector In view of the war in Ukraine, the federal government must now work to preserve the economic strength of the business sector and rapidly develop and implement effective, targeted and temporary measures

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

to cushion the impact of the crisis. German industry sees a risk that rising energy prices or the suspension of Russian energy exports could threaten the economic survival of companies.

Some energy-intensive companies are already being forced to curb their production due to the runaway costs of gas and electricity. In individual cases, interim tools such as guarantees, loans and public participations should be made available to at-risk companies along the lines of the German Economic Stabilization Fund established during the Covid crisis. The coalition government should initiate a programme by the German Development Bank to swiftly provide hard-hit companies with liquidity in the form of loans. The planned supplementary budget should swiftly incorporate the necessary federal guarantee scheme.

It is foreseeable that grid fees will be the part of electricity costs that increase the fastest. The legislator should pull forward the co-financing planned for the coming year to this year to provide swifter relief for citizens and companies. The federal government should include targeted and temporary grants in the third relief package for companies that face financial difficulties because of energy prices and through no fault of their own.

In tax policy, the losses caused by the appropriation or the default of intergroup receivables in Russia and Ukraine because of the current situation should be tax deductible. Regarding energy tax, a reduction of the electricity tax to the EU minimum tax rate is overdue. Follow-on regulations for the energy tax relief schemes that expire this year are also urgently needed.

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

Sources Bachmann et al. (2022). Was wäre, wenn …? Die wirtschaftspolitischen Auswirkungen eines Importstopps russischer Energie auf Deutschland. ECONtribute Policy Brief No. 029.

DIW (2022). Stopp russischer Energieeinfuhren würde deutsche Wirtschaft spürbar treffe, Fiskalpolitik wäre in der Verantwortung. DIW aktuell Nr. 80. 29 March. Berlin.

European Central Bank (2022). ECB macroeconomic staff projections for the euro area. 10 March.

Frankfurt/M. Ifo (2002). Schnelldienst Digital 1/2022, 23 March. Munich.

IMK (2022). Ukraine-Krieg erschwert Erholung nach Pandemie. IMK-Report Nr. 174.

IW Köln (2022). Report 11/2022, Institut der deutschen Wirtschaft. Cologne. March.

OECD (2022). Economic Outlook, Interim Report. 17 March. Paris.

SVR (2022). Aktualisierte Konjunkturprognose 2022 und 2023. 30 March. Wiesbaden.

Imprint Bundesverband der Deutschen Industrie e.V. (BDI) Breite Straße 29 10178 Berlin T: +49 30 2028-0 www.bdi.eu Lobbyregisternummer R000534 Author Thomas Hüne T: +49 30 2028-1592 t.huene@bdi.eu Editorial / Graphics Dr. Klaus Günter Deutsch T: +49 30 2028-1591 k.deutsch@bdi.eu Marta Gancarek T: +49 30 2028-1588 m.gancarek@bdi.eu

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Ukraine war dampens investment | Economic uncertainty jeopardises recovery in 2022 11/04/2022

Basic data for national accounts GDP (price, seasonally and calendar adjusted) Change over previous period in percent 2020 2020

2021

2021

Q3

Q4

Q1

Q2

Q3

Q4

-3.2

1.1

8.3

-1.7

-3.9

4.2

3.2

-0.9

-Private Consumption

-5.9

0.1

11.5

-2.7

-5.2

3.7

6.0

-1.8

-Public Consumption

3.5

3.1

1.5

0.8

-1.1

5.1

-2.8

1.0

-2.2

1.5

4.6

2.4

-0.5

1.3

-2.9

0.5

-11.2

3.4

16.7

1.9

-0.4

0.6

-3.9

0.9

-Construction

2.5

0.7

-0.9

2.9

0.2

1.7

-3.6

0.0

-Other

1.0

0.7

2.8

1.7

-2.6

1.1

0.9

1.3

Domestic Demand

-4.0

2.2

5.6

-0.3

-1.0

2.8

1.7

-0.5

Exports

-9.3

9.9

17.5

4.6

1.9

1.1

0.0

4.8

Imports

-8.6

9.3

9.3

2.7

4.3

2.3

-0.1

5.1

Total

-4.6

2.9

9.0

0.7

-1.7

2.2

1.7

-0.3

Consumption

Investment -Machinery and Equipment

Contribution to growth (in percentage points) Consumption

-2.3

0.8

6.2

-1.2

-2.8

2.9

2.3

-0.7

-Private Consumption

-3.0

0.1

5.8

-1.4

-2.6

1.8

2.9

-0.9

-Public Consumption

0.7

0.7

0.4

0.2

-0.3

1.2

-0.7

0.2

-0.8

0.3

1.0

0.5

-0.1

0.3

-0.6

0.1

-0.9

0.2

1.0

0.1

0.0

0.0

-0.3

0.1

-Construction

0.2

0.1

-0.1

0.3

0.0

0.2

-0.4

0.0

-Other

0.0

0.0

0.1

0.1

-0.1

0.0

0.0

0.1

Change in stocks

-0.7

1.0

-1.8

0.5

2.1

-0.6

0.0

0.1

Domestic Demand

-3.7

2.1

5.5

-0.2

-0.9

2.6

1.6

-0.5

Net exports

-0.8

0.8

3.6

1.0

-0.8

-0.4

0.1

0.2

Investment -Machinery and Equipment

Source: Federal Statistical Office

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