Debts & Loans

German government efforts to support the economy through record borrowing may aggravate a shortage of funding for the private sector which threatens to crimp investment, accelerate job losses and stifle a recovery.

German industry associations say banks' reluctance to lend is putting firms under increasing pressure to find alternative sources of funding -- at a time when governments are sucking up more and more of the money available on capital markets.

Yet the more companies have suffered in the downturn, the more the state has had to borrow to help them out. "It's a vicious circle -- it's like a dog biting itself on the tail," said Volker Treier, chief economist of Germany's chamber of industry and commerce (DIHK).

Germany and other European states are selling record levels of debt to help shore up their economies, prompting the Bank for International Settlements to warn this spring that sovereign issuers alone face increasing competition for investors. Treier said there was no definitive evidence yet that firms have been crowded out of capital markets by the government, which is battling an expected economic contraction of 6 percent in 2009. But there were signs it could be happening, he said.

For the first time, DIHK surveys of German industry showed that financing conditions for bigger firms -- those most likely to seek funds on capital markets -- were deteriorating more rapidly than those for smaller firms, Treier said.

Yet this in turn could have a knock-on effect for borrowers who cannot turn to capital markets for funding. The European Central Bank has pumped billions of euros into markets to encourage bank lending, but it hasn't solved the problem, said Mario Ohoven, president of the BVMW association of small- and medium-sized businesses, known as the Mittelstand.

"The situation has got worse," Ohoven told Reuters. "We know from our members...that more than 40 percent of Mittelstand firms are reporting tougher access to credit." According to the Bundesbank, the volume of loans issued by banks to non-banks fell during four of the past five months up to March, the most recent period for which data is available.

Part of the problem could be seen in the billions of euros worth of repair work done by the state guaranteeing bank loans, which drew capital away from nominally riskier sources of funding, said Johannes Rudolph, an analyst at HSBC Trinkaus. "I don't think the state itself is squeezing out other borrowers directly," he said. "It's the loans guaranteed by the state -- they are crowding out other non-guaranteed loans."

Consolidation in the banking sector and the need for bigger capital cushions has also played its part in the process. "It's not so much the price borrowers pay, it's the amount on offer. On the one hand, there are fewer banks, on the other, they must keep a closer watch on their capital," Rudolph said.

The cabinet on Wednesday backed a supplementary budget which raises the federal new borrowing target by nearly 11 billion euros ($15.4 billion) to a record 47.6 billion euros in 2009. Coupled with extra funds raised through state-controlled bodies to support struggling banks and firms, new borrowing may exceed 80 billion euros. As a result, federal debt issuance, already set for nearly 350 billion in 2009, could rise further.

Markets have been rocked in recent weeks by concerns that mounting public debt levels might threaten the top notch credit ratings of issuers like the United States and Britain. The cost of raising debt has risen steadily from historical lows since the start of this year, with the German 10-year Bund yield climbing some 70 basis points by late May.

"If the state has to pay more for debt, then obviously companies will have to pay more on top of that," said Kai Carstensen, chief economist of the Ifo research institute. For all the funding difficulties, observers note that German companies have a stronger capital base than during the last marked economic downturn at the outset of the decade.

German construction firms' capital ratios rose to roughly 10-12 percent on average by 2007 from around 3-4 percent in 2001/2002, according to the HDB industry association. However, such reserves can only last for so long. Treier at the DIHK said it was not just a question of firms securing funding to invest: some needed it just to survive.

"So firms are doubly under pressure -- that's why they're switching to shorter hours like crazy," said Treier of the state-subsidized programme to support reduced working times. A number of Germany's best known companies have turned to the state for financial support during the crisis, among them carmaker Porsche, lender Commerzbank and printing machine maker Heidelberger Druck.

Many more have resorted to Kurzarbeit, or shortened hours. "There's talk now that shortened hours won't bridge the gap for much longer," Treier added. "So we could be set for a few nasty surprises in some quarters on the job front."