German Economy at Risk Unless Turmoil Is Contained

Those who fear that Germany’s role as the biggest lender to foundering Russia has put the economic powerhouse of Europe at risk of its own tumble have only to look at its strengthening currency and unshaken growth outlook for reassurance.

But as contagion from the Russian crisis and relapses from last year’s Asian meltdown sweep from continent to continent and investors worldwide lose their nerve in emerging markets, economists warn that Germany, the world’s third-largest economy, also will be hurt unless governments act to contain the global panic.

Russia owes more than $30 billion to German banks. Even though it has promised to continue servicing government-backed debts, which make up the bulk of German exposure, the persistent political instability in Russia is nurturing concern there could be sizable defaults.

“It will hit us harder than anyone else because Russia has most of its foreign debt with us,” said Wolfram Schrettl, chief of international economics at the influential German Institute for Economic Research in Berlin. “In the overall German portfolio, however, this is still not a lot.”

Even in the worst-case scenario of Moscow abandoning its foreign obligations--something economists describe as “a very extreme assumption”--the burden on wealthy Germany’s budget would be minimal.

“It’s very unlikely that all government credits would be defaulted. No one thinks this will happen,” said Klaus Papenbrock, an economist in the German sector of Frankfurt-based Deutsche Bank.

No matter what ideology prevails in the next Russian government, he said, Moscow will need to maintain its economic relationships in the West.

Shipments to Russia have soared 30% this year but still account for only 2% of overall German exports. Yet fears that Moscow’s money woes mean that Russia will be buying less, affecting markets throughout Europe, have driven share prices down 14% on the German stock exchange since the ruble was devalued nearly four weeks ago.

But the hardy mark has benefited from the more worrisome U.S. market fluctuations amid fears that Latin American economies may be the next to wobble. The U.S. currency’s value against the mark has fallen from 1.81 to the dollar a week ago to 1.73 on Friday, its lowest level since last November.

Germany’s banking sector, however, is likely to sustain some damage, as would the 1999 budget deficit if the government is left to cover losses on state-guaranteed loans.

Even an unlikely across-the-board Russian default, though, would add no more than 0.1% or 0.2% to next year’s projected 2% deficit-to-GDP ratio, said Michael Clauss, director of economics for Credit Suisse First Boston in London.

If the losses are spread over the next few years, he added, that would allow Germany to stay well within the parameters set down for the European economic union that begins in earnest in January with introduction of a common currency, the euro.

What analysts fear more than bad loans or the long-expected correction in share prices is investor overreaction to Moscow’s chaos. Investors are fleeing emerging markets that are more important to the German economy, notably the reformed and relatively stable markets of Poland, Hungary and the Czech Republic.

“The risk is that you will see investors and capital pulling out of these countries because of the fear of contagion,” said Joachim Fels, chief economist with Morgan Stanley Dean Witter in London, noting that the economies of Eastern Europe are generally sound. “There is no real reason to be overly negative.”

That said, if investors write off emerging markets regardless of their individual merits, a drop in demand for German products in Eastern Europe could shave off as much as a full percentage point from Germany’s expected 2.5% growth in GDP next year.

“Most of this is psychological reaction,” Fels said of the global rush of capital to the havens of U.S. and German bonds. “Investors everywhere now have less appetite for risk.”

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To stabilize global markets that have been roiling since last year’s Asian stock free falls, nations belonging to the Group of Seven industrial powers must take the potentially unpopular steps of paring down their trade surpluses with less prosperous countries and loosening the money supply, according to the latest advice from the Berlin economic research institute known by its German initials, DIW.

On Wednesday, DIW called on Germany and other European states to sharply lower interest rates to encourage domestic investment and reduce dependence on exports. Similar pleas are being made to the U.S. Federal Reserve.

Lower interest rates in the major trading nations would also ease pressures on emerging nations, which have boosted interest rates to protect their currencies but damaging their economies in the process.

Without lower rates, “The danger of an international depression can no longer be denied,” DIW warned in its weekly position paper. “Reviving domestic demand in Germany and Europe represents the only effective counterweight to a collapse in global demand.”

Germany’s central bank, the Bundesbank, fears lower interest rates will complicate Germany’s attempts to assimilate rates with other European states as all prepare to use the euro beginning Jan. 1. And Chancellor Helmut Kohl’s government has been all but paralyzed on economic matters by a contentious federal election looming a mere three weeks away.

Germany’s role in the Russian crisis has become a heated topic in the campaign between Kohl and his Social Democratic Party challenger, Gerhard Schroeder.

The 68-year-old incumbent cast himself as the proven elder statesman needed at Germany’s helm in times of international crises like this one. But Schroeder accuses Kohl of putting German prosperity at risk by trusting the dubious economic policies of Russian President Boris N. Yeltsin.