Germanys Economic Performance during the Credit Crunch - Assignment Example

Case Study: Germany and BMW Surviving the Credit Crunch Unit Question (a) IntroductionIn the beginning of the 21st century, various developed economies were experiencing a boom that led to an immediate recession after a span of 5 years. Due to globalization, the economic recession hit both the US and Europe. An intense focus emerged in Europe when Greece announced that its economy was in the verge of collapse. This led to one standing economy, Germany, contributing to its bail out. So how did Germany survive the global credit crunch? Throughout this case study, I will highlight German’s economic indicators from the period of the financial crisis to date and also talk about monetary policies that may have put Germany in a strong position during the credit crunch. German ultimately became the major supplier of bailout funds to ailing European economies. This can be attributed to Germany having better cash reserves in most of their banks and also maintaining strict measures for mortgage qualifications (DAUM & EVENETT, 2012). Germany’s Economic Performance during the Credit Crunch Germany started a pro-growth deficit reduction course in 2001 coupled with structural labour markets policy reforms. The country also lowered income tax in order to implement vital labour reforms and improve growth. These eventually gave manufacturers and labourers incentive to improve productivity. In order to reduce the costs involved in its public pension program, Germany removed early retirement clauses, proactively reviewed its pension’s contributions rates and increased the statutory retirement age (AIZENMAN, 2014). In addition Germany also applied cuts to its public sector, this include eliminating Christmas related bonuses and subsidies reduction for various industries. Countries like Australia and Germany that applied tight fiscal policies and reform entitlements before the credit crunch had more flexibility during the crisis and they were less likely to be adversely affected in the long run. Germany’s Annual GDP From 2006-2014 GDP growth (annual %) YR2006 3.710003277 GDP growth (annual %) YR2007 3.269782782 GDP growth (annual %) YR2008 1.052109101 GDP growth (annual %) YR2009 -5.637953129 GDP growth (annual %) YR2010 4.090767318 GDP growth (annual %) YR2011 3.590000079 GDP growth (annual %) YR2012 0.376484292 GDP growth (annual %) YR2013 0.105789496 GDP growth (annual %) YR2014 .. Graphical Representation: Source- World Bank Data Bank and Indicators From the chart above, you can see that, Germany was negatively affected in 2009 exhibiting a GDP growth of -5.6% (when the financial crisis was at its all-time high), and then its economy bounced right back in 2010 exhibiting a GDP growth of 4.1%.This was still attributed in marginal increases in exports of commodities like luxury cars to other emerging markets and low inflation during 2009. Inflation Rates and Germany Exclusivity from Eurozone 2006-2014 Inflation, consumer prices (annual %) YR2006 1.577429241 Inflation, consumer prices (annual %) YR2007 2.29834058 Inflation, consumer prices (annual %) YR2008 2.628383067 Inflation, consumer prices (annual %) YR2009 0.312737723 Inflation, consumer prices (annual %) YR2010 1.103808561 Inflation, consumer prices (annual %) YR2011 2.075172931 Inflation, consumer prices (annual %) YR2012 2.008491182 Inflation, consumer prices (annual %) YR2013 1.504722267 Inflation, consumer prices (annual %) YR2014 .. Graphical Representation: Source- World Bank Data Bank/Indicators Mr Pettis claim that Germany has greatly benefited from the Euro. He says the account imbalances within the Eurozone contributed to employment growth in economies that had suppressed consumption. This forces the countries that didn’t do so to either choose between unemployment and debt (The Economist). Obviously, countries that did not supress consumption barely had control over monetary policy and therefore decision were made on their behalf by the ECB (European Central Bank) with its very low interest rate (low inflation rates), and their debt level went up. Germany lost the gain of low interest rates after its onset and partially because of the euro. This led to capital inflow into neighbouring countries of Germany, while investment marginally declined in Germany in 2009, leading to persistently high unemployment, low growth and low inflation. This was contributed by Germany’s attempt to exclude itself from the EU and therefore avoid the Euro currency volatility. Unemployment Role in Germany 2006 -2014 Graphical Representation: Source- World Bank Data Bank/Indicators In the period of the recession, Germany gained from an alternative to increased unemployment, also called the Kurzabeit policy. Kurzabeit federal subsidy worked in an efficient way for the unemployed. Labourers had their working hours reduced during the cyclical reduction in demand. This eventually encouraged German employers to retain their skilled staff and therefore production recovered faster in tandem with demand growth. Keeping employees on staff during the credit crunch instead of laying them off helped producers in Germany take advantage of rising demand when the recession relaxed. This essentially reduced the unemployment rate gradually as shown on the chart above (BOHACHOVA, BOOCKMAN & BUCH, 2011). Balance of payment (BOP) and Debt Effect Germany has exhibited a steady positive balance of payment. It no doubt that Germany has greatly benefited from free trade in Europe. Considering Germany is a major net exporting country. The steady surplus above is attributed to; Its currency undervaluation since the year 2000. German labour cost rose by about 25% less than its Eurozone competitors. This means that Germans export, with no currency risk, German exports have become 25% more competitive. The weak consumer demand is exhibited in Germany. Domestic savings is high while spending is low. This is because Germans growth is more induced by exports compared to domestic expenditure. Research by McKinsey show that the domestic public and private sector debt grew by 150 percent in Spain, 83 percent in France, 70 percent in the United Stated and 157 percent in the UK. In Germany, the debt (Eurobond issue) grew only by 7 percent. This is one major reason why Germany’s economy was still in a great shape after the financial crisis even though it was considerably affected by collapse in trade. Question (b) Bayerische Motoren Werke (BMW) Germany Bayerische Motoren Werke (BMW) is a major German holding company that focuses on the motorcycle and automobile markets. The Company’s main segments are in Automobiles and Motorcycles and it recently opened a Financial Services division in order to boost business operations. It owns three brands: BMW, MINI and Rolls-Royce. BMW is listed in the Frankfurt and Stuttgart stock exchanges. BMW share price has been bullish since 2004, with the company equity price sustaining positive growth through the credit crunch. BMW currently trade at approximately 90 Euros in the two stock exchanges. Source: Google Finance. BMW Financials from 2006 to 2014 Values are in ‘000,000’ Source: http://financials.morningstar.com/ratios/r.html?t=XSTU:BMW®ion=deu&culture=en-US Across all entries above one can see that BMW has exhibited growth in revenue for the past 7 years. Though it is important to note that revenue declined in 2008 and 2009 (at the height of the credit crunch). Revenue grew from 48B Euros to 77B Euros as a result of growing demand for luxury cars in the US. The net effect is the net income increase and therefore EPS (Earnings per Share) increased too (from 4.38Euros/Share in 2006 to 8.88Euros/Share in 2013). By concentrating on quality production and technology inclusion and innovation for their vehicle, BMW has managed to sustain their export number throughout the years (except in 2008 and 2009). A reduction in operating cash flow was also exhibited as BMW opened a financial services division (VALECKÝ & WANG, 2013). BMW Sources of Funding Between 2006 and 2014 Prior to the crisis, BMW pretty much survived without debt financing. Sources of funding were generally debentures and commercial papers. However during the period of financial crisis, BMW was in financial distress to meet demand in emerging market like China. Reduced revenue during the crisis led to BMW tapping the Bonds Market as corporate debt risk rose between 2010 and 2013. In 2011 BMW issued a €1Billion bond, this was the first sizeable sale of investment-grade European corporate debt that took place in 2 weeks after a new bailout package for Greece and expanded efforts for the EU’s rescue fund improved investors sentiment (FINANCIAL TIMES). Furthermore, BMW also sold $2.3 billion (1.75bn Euros) of high-ranking unsecured bonds at the beginning of 2013, “this has been its largest offering in the currency for a year, according to data compiled by Bloomberg” (BLOOMBERG). This was a strategic move by the Munich-based BMW in an attempt to increase level auto sales in 2013 as China and the U.S. offset falling demand in Europe. Gearing/Leverage Ratio and Profitability from 2006 to 2014 Profitability 2006-12 2007-12 2008-12 2009-12 2010-12 2011-12 2012-12 2013-12 TTM Tax Rate % 30.31 19.08 5.98 49.15 33.13 33.54 34.49 32.52 32.94 Net Margin % 5.85 5.58 0.61 0.4 5.32 7.09 6.63 6.41 6.86 Asset Turnover (Average) 0.64 0.67 0.56 0.5 0.57 0.59 0.6 0.56 0.54 Return on Assets % 3.73 3.72 0.34 0.2 3.05 4.2 3.99 3.61 3.73 Financial Leverage /Gearing (Average) 4.13 4.1 4.99 5.12 4.71 4.55 4.34 3.88 4.07 Return on Equity % 15.89 15.3 1.54 1.02 14.96 19.45 17.72 14.77 15.1 Return on Invested Capital % 5.35 5.16 1.64 1.32 4.64 6.1 5.28 4.8 4.94 Interest Coverage 1.38 1.41 6.01 8.83 Source: http://financials.morningstar.com/ratios/r.html?t=XSTU:BMW®ion=deu&culture=en-US BMW has managed to maintain it financial leverage level at 4. The highest gearing levels/ratios obviously occurred in 2008 (at 4.99) and 2009 (at 5.12). Borrowing substantially increased during this period due to financial stress the company witness from slumping demand in the US. The profit margin was also affected in 2008 (at 0.61%) and 2009 (at 5.32%). However, BMW diversification has enabled it increase its profit margin form 5.85% (in 2006) to 6.41 (in 2013). This was contributed by corporate bond issues in 2011 and 2013 that boosted the financial service division of BMW (VALECKÝ & WANG, 2013). BMW using Currency Swaps to Manage Currency Risk In wake of the credit crunch, in 2008, BMW encountered a very challenging problem in its US auto sales. Its main growth region for ‘X series’ automobiles was the US. However, because these cars are manufactured in Germany, the euro’s strength against the US dollar was making the cars too expensive in the US. In addition, during that period, the euro was expected to strengthen against the US dollar over the coming months. So what could BMW do to ensure that the ‘X series’ cars did not become too expensive in the United States? In order to protect itself from currency fluctuation between Euro and USD, BMW used currency swaps on occasions. For example, when the exchange rate was $2= 1 Euro, then for every $100million sale to the US took place, BMW would receive 50million Euros regardless of the exchange rate at the current time (CHOI & PAPAIOANNOU, 2009). BMW Performance Compared to Volkswagen and Daimler Key economic figures for BMW, Volkswagen and Daimler in FY 2013 Source: http://www.statista.com/statistics/273210/company-figures-of-the-automoblie-companies-bmw-vw-and-daimler/ The combined annual revenue of Daimler, Volkswagen and BMW is almost equal to the GDP of Belgium. The three German automobile manufacturers managed to survive the European financial crisis, referred to as “carmageddon” (JP Morgan). Volkswagen higher revenue can be attributed to its mass/volume production and discount pricing strategy. The premium pricing on Daimler and BMW is justified by the statistic that both car makers sell bigger and more quality expensive cars – a market segment more profitable compared to the entire automobile market (STATISTA, 2007). BMW has operating margins of around 11%, approximately twice the industry’s average. This is similarly observed for Volkswagen’s high-end brand Audi. How the Scrappage Program helped Germany Automobile Industry The Scrappage program in Germany has been the largest, probably in Europe. Car owners with vehicles older than 9 years were entitled to a Scrappage premium of 2500Euros ($3,200) when they bought a new car. The unexpected automobile sales boom in 2009 compared to 2008 however made the Scrappage scheme short running. As much it was a short term stimulus, various car makers benefited from it (WITTE, 2013). 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