Volkswagen crisis and its risk to Germany

The most recent survey data coming out of both Germany and the rest of the Eurozone have continued to show a positive outlook for German growth and the car industry in general. However, these results pre-date the Volkswagen (VW) crisis. 

More specifically, in September, the German Ifo surprised on the upside, moving up to 108.5, well above its long term average (around 102) and consistent with GDP growth of around 2.5% y/y. Meanwhile, European car registrations increased by roughly 10% y/y in August. Eurozone consumer confidence was also strong in September, as well as survey details on household intentions to buy big ticket items. These metrics suggest that 2015 is (or at least was) on track to be a strong year for the car industry. This should have been good news for German automakers, and therefore, the German economy as a whole given that the manufacturing sector accounts for around 23% of GDP - well above the Eurozone average of around 16%.

However, since the news of the VW scandal erupted at the end of September, there is a serious risk that the buoyancy of the German auto sector (and even manufacturing more generally) could suffer a big setback. Given the close relationship between German manufacturing and GDP, there is a possibility of a poor end to the year for growth. Thankfully, this kind of event does not happen often, so it is hard to quantify exactly what the fallout might be. Nonetheless, we can look at some broad figures to gauge the impact.

Volkswagen has become the largest car manufacturer in the world, with more than 10 million vehicles sold across the world last year. In terms of production, 25% is made in Germany and 75% in the rest of the world. So, this crisis is likely to have negative consequences for a number of economies. We focus on the specific case of Germany. In Germany, as mentioned above, the manufacturing sector accounts for around 23% of GDP and among this, 15% is car production. Volkswagen produced more than 2.5 million cars last years in Germany, which represents 45% of total German car production. In turn, that means that Volkswagen production accounts for 6% of the German manufacturing sector or 1.4% of German GDP. 

According to the press, around 11 million diesel vehicles across the world will be recalled. The press has also mentioned that some countries have halted deliveries of diesel cars from Volkswagen. In view of the share metrics above, we could say that the direct impact of a 10% drop in car production from Volkswagen would cut German GDP growth by around 0.15%. However, there would also likely be an additional indirect impact from the number of suppliers that also stand to suffer. 

"If we look at the historical relationship between auto production and German manufacturing output, there is, unsurprisingly, a strong correlation with an elasticity of around 0.5 over the period 2007/2014. So, a 10% fall in VW production could end up having an impact of between 2.0% and 2.5% on the manufacturing sector as a whole, which therefore, could subtract 0.5% from German GDP," notes Scotiabank research.

Upcoming business surveys will be the first gauge of the magnitude of the VW crisis on German GDP growth.

"There is a risk that the survey data will over-react. A prime example of this is the ZEW survey, which is the first business survey released each month. This is a survey of financial market professionals rather than hard business activity. It also tends to be very volatile, so the upcoming ZEW index should be interpreted with caution," further noted Scotiabank.