RWI Essen has adjusted its forecast for real gross domestic product (GDP) growth in 2009 compared to its September forecast by 2.7 percentage points down to -2.0%. The reason for this is that the financial market crisis is having a far more serious effect on the global economy than was previously foreseeable. German exports in particular are likely to be substantially impacted, with employment and state receipts declining at the same time. However, we expect private consumption to remain stable until at least mid-2009, especially in light of the inflation rate falling to an annual average of 0.9%. To mitigate the effect of the imminent recession in the coming year, RWI Essen proposes a reform of income tax rates to reduce the tax load on German citizens by 25 bn Euro. Doing so could help to achieve positive GDP growth as early as the second half of 2009.

This is the second time that RWI Essen has substantially revised its 2009 forecast for Germany downward. While, in September, we still anticipated an increase of 0.7% in the gross domestic product (GDP) for 2009, all business indicators have since considerably deteriorated so that we must now assume that the GDP will fall by an annual average of 2.0% in real terms in 2009. This would be the strongest decline of economic activity that the Federal Republic has ever recorded. After three quarters with a receding GDP in this year, economic performance is likely to continue to drop in 2009. A slight recovery will not be noticeable until the end of the year when financial market stabilization measures and the expansive financial and monetary policy measures adopted by many countries start to take effect.

In the past few months, business activity has slackened worldwide, including in Germany, to a far greater extent than we forecasted in September, when our last forecast was finished on September 12. Up to this point, many indicators suggested that the situation on the financial markets would calm down. However, the insolvency of the US investment bank Lehman Brothers on September 15 triggered an obvious downward spiral. As this was the first time that a major bank had become insolvent, the impact on confidence in the financial sector was so severe that the crisis on the financial market spread to other market segments that had, for the most part, previously been unaffected by it. In particular, emerging markets, which many expected to be a stabilizing element in the global economy up to a few months ago, have been noticeably affected.

Exports are likely to continue dropping initially, while private consumption remains stable

The recession in Germany has significantly affected by the slackening of the global economy and the resulting decline in exports. Since economic problems are becoming apparent in more and more countries, the decline in exports is likely to persist for the time being. Sales forecasts for German companies remain unfavorable so that investments will set the pace of the recession - much in the same way as in past business cycles. This is all the more true as the cost of financing has increased and orders that have already been placed can no longer be filled, or are subject to delays, because purchasers are experiencing financing problems. Unless sales and income expectations improve, the more favorable write-off requirements adopted by the German government to stabilize business activity will have little effect. All told, we expect fixed investment to drop by an average of 10% in the coming year. This will also impact investments in building, especially in light of the fact that large-scale projects are being postponed. Although the German government is allocating an additional one billion euros to public spending this year, that is little more than a drop in the bucket.

The only stabilizing factors right now is private consumer spending, where several factors play a role. Wages will again increase considerably as they were already settled in 2008. Pensions are likely to rise by some 2.5 %, since they follow wage trends with some delay, and some benefits such as child allowance have also been increased. But above all, inflation is likely to continue to fall, particularly as a consequence of the drop in world market prices for raw materials and energy. We predict an increase in consumer prices of just 0.9% for 2009. Disposible real income is likely to improve until mid-2009, which should promote private consumption. However, ongoing deterioration of the labour market in the course of the year is likely to have an increasingly negative impact.

Employment and state income will drop next year

Thus far, employment has turned out to be surprisingly robust considering the fact that production figures have been declining for some time. However, the weak economy is likely to affect the labour market from now on, causing employment to fall and unemployment to rise. Many companies will probably attempt to avoid redundancies at first, and instead introduce short-time work, or reduce their staff's "banked" hours. At the same time, however, the number of people in employment is likely to drop by around 700,000 by the end of 2009, with unemployment figures increasing by almost 600,000.

Public budgets are likely to deteriorate as a consequence of the recession. For one thing, more state expenditure has been approved and new subsidies have been introduced to stabilize the economy. For another, tax revenues, especially from profit-related taxes, are likely to decline. All told, we expect a more or less balanced budget in 2008; for 2009 a deficit of 1.1% of GDP is forecasted. This does not take into account spending following from the Financial Market Stabilization Act as it is currently impossible to quantify them exactly since only a portion of the resources have even been used.

Income tax reform could mitigate recession

Our appraisal of the situation is that Germany is in deep recession. The stabilization measures passed thus far are unlikely to bring about a change for the better. The government puts these measures at 32 billion euros. However, some of these programs are scheduled to run for several years, and the restrictive effects of increasing health insurance contributions have to be offset. We estimate the boost in growth provided by the financial policy in the coming year at 10 billion euros.

However, politicians do have a genuine option for mitigating the decline in the coming years and for more quickly putting the German economy back onto an upward path of expansion. If the government were to quickly introduce a reform of income tax rates, following our recommendations, and thus reduce the tax burden on the population by some 25 billion euros (1% of the GDP), the GDP could achieve a 0.7% higher figure than forecast in this publication. This would considerably curb the extent of the recession; in particular it would be possible to achieve positive figures again in the second half of the year.

For further information, please contact: :
Dr. Roland Döhrn, Tel.: +49 201 81 49-262, e-mail
Sabine Weiler (Pressestelle), Tel.: +49 201 81 49-213, e-mail