The People’s Republic of China currently has severe economic problems to contend with that could also spill over to Germany. On top of that, relations between advanced economies in the West and China have worsened noticeably of late, as reflected in an uptick in trade and geopolitical tensions. The Bundesbank singles out geopolitical developments as a major source of risk to economic relations. “If these risks materialise, Germany’s economy could take a huge hit,” the Bank’s experts write in an article exploring Germany’s dependence on China. The article looks into the extent to which Germany’s economy could cope with an economic crisis in China or an abrupt decoupling from that country. It also considers potential supply chain disruptions and, in particular, the risks to financial stability. 

German economy heavily dependent on China

“An economic crisis in China similar to those that have occurred in the past in other countries following a correction of excessive credit growth would arguably be manageable for the German economy,” the article’s authors write. Bundesbank calculations suggest that an economic crisis in China could leave real gross domestic product 0.7% down on what would otherwise be expected in the first year of the crisis, followed by losses of 1% in the second year. 

“However, an abrupt decoupling, say as a result of a geopolitical crisis, would deal a far heavier blow to German industry, in particular,” the authors added, noting that firms directly invested in China stood to lose a substantial part of their sales and profit base. Granted, just 7% of total German goods exports went to China in 2022, but there are some sectors, like the automotive sector, mechanical engineering, electronics and electrical engineering, that are significantly more reliant on Chinese demand. 

Far larger, the authors explained, is the group of firms that are directly or indirectly reliant on Chinese critical intermediate inputs like batteries and energy storage devices as well as some raw materials such as rare earths. If those supplies were to dry up, Germany could well experience severe production losses. A representative Bundesbank survey has found that nearly one out of every two firms in the manufacturing sector directly or indirectly sources critical intermediate inputs from China. There was also the matter of spillover effects that could spark similar problems in other economies. “The associated heightened economic uncertainty would mean that other sectors of the German economy would probably be affected as well,” the authors noted. “Overall, the economic losses would arguably clearly eclipse the costs of the extensive decoupling from Russia.”

Financial system also at risk

“The close real economic ties between Germany and China also give rise to considerable risks for the German financial system,” the experts write. Granted, German financial intermediaries’ direct ties with China are reported as being fairly small. Compared with borrowers from other countries, China comes just 20th in terms of total amounts borrowed and has not risen significantly through the rankings in recent years either. According to the experts, German banks have large exposures to domestic enterprises and sectors that are heavily dependent on China. A far-reaching disruption to German-Chinese economic relations would affect these significantly and ultimately increase the probability of loans defaulting. On top of this, the experts added, the German financial system would likely face further burdens, including a general loss of confidence on the part of the global financial markets.

Dependence, risks, but also benefits of close economic ties with China

In their report, the authors also take into account the advantages of close ties with China in their risk assessment. In the past, they write, many German industrial firms have generated high sales and profits from production in China and high revenues from exports to China. “A move away from China would therefore likely entail business and economic costs in the long term, too,” the experts write. “This is true even given an orderly and gradual de-risking.” German enterprises would miss out on a key sales market, and many supply chains could arguably be realigned only at the expense of losses in efficiency. In addition, he continued, there are some products where China has a strong or quasi-monopolistic position, where dependence could be reduced only in the medium to long term, if at all.

The authors therefore argue against a unilateral departure from China, but call for further de-risking: they call on firms and policymakers to continue attempting to de-risk and to strengthen the resilience of the German economy.