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SMT & Inspection | March 31, 2010

German machinery manufacturers skating on thin ice

For Germany’s plant and machinery manufacturers, 2009 was the worst year for decades. The sector had to cope with an almost-25-per-cent fall in production output, the German industry association VDMA states.
For the ongoing year of 2010, the VDMA expects that the German mechanical engineering sector will be able to more or less maintain last year’s production volume overall, with a slight uptrend over the course of the year. At the VDMA’s annual press conference, Dr. Ralph Wiechers, the organisation’s chief economist, talked about the development.

Germany's plant and machinery manufacturers are suffering the severest crisis of the post-war era. A year ago you were hoping for stagnation in machinery production output at best. What's gone wrong?
Even for the plant and machinery manufacturers, who are familiar with severe cyclical fluctuations and know how to cope with them, 2009 was a cataclysm. The massive loss of confidence on the financial markets evolved into a globe-girdling economic crisis. Machinery customers at home and abroad reacted with growing uncertainty - and imposed far-reaching curbs on investment and expenditure.

The severity of the crisis, and the sheer speed with which it engulfed us, were doubtless foreseen by very few of my colleagues. This does not, however, mean that we were totally unprepared. There were more than vague signs of an imminent downturn. Back in the autumn of 2007, the early-warning indicators had already been triggered worldwide.

In Germany, order bookings in the mechanical engineering sector during April 2008 had, admittedly, soared once again by 35% compared to the previous year's equivalent figure. But we were becoming more and more uneasy in view of the bottlenecks and the overheating on the markets. An uncomfortable situation. But, as we quickly saw, it soon became even more uncomfortable.

What specifically do you mean by "uncomfortable"?
Following the collapse of the Lehmann Brothers Bank, machinery orders fell more quickly and more dramatically than at any time since the VDAM began keeping order booking statistics back in 1958. In 2009 order bookings on a price-adjusted basis were 38% below the admittedly very high figure for the preceding year's equivalent period. May 2009, with an index figure of 66, marks the lowest point on the order curve. This corresponds to a level one third below the average sales of the year 2005!

A situation exacerbated by massive cancellations. What were sometimes ample order cushions from the boom years simply melted away. For this reason, the declines in order bookings quickly showed up in the machinery production output figures. After price adjustment, they were around 25% down on the preceding year's figure. Capacity utilisation, another yardstick for the business situation at mechanical engineering companies, fell in the summer of 2009 below the 70-per-cent mark - likewise a negative record!

Against this background, the fall in permanent payrolls has so far proved comparatively moderate, thanks to downsizing of worktime accounts, dispensing with temporary workers, short-time working for the permanent staff and plant-specific initiatives. For instance, the number of people employed in 2009 fell by almost 34,000 or by just 3,5%.

Germany's mechanical engineering industry is a highly diverse sector. Have there been disparate developments in the subsectors?
As always, these average figures for Germany's mechanical engineering sector conceal an exceptionally broad spread. Companies operating in the categories of metallurgical plants and rolling mills and mining machinery can in some cases report very substantial rises in sales overall for 2009, thanks to high order backlogs and long throughput times.

Manufacturers of construction and construction-material machinery, fluid technology, woodworking machines and textile machinery are seeing their sales fall by 40% and more. The construction-linked sectors were hit pretty early and severely by the crisis. After all, it did in fact originate in the property sector. The manufacturers of hydraulic parts, like numerous other component suppliers suffered from massive order cancellations by their customers, who were drastically downsizing their inventories.

Germany's plant and machinery manufacturers are said to be hit particularly hard due to their high proportion of exports. Is that true, or are the manufacturers in other countries being equally affected?
Machinery sales worldwide in 2009 are estimated to have fallen by a total of 19% in real terms. Europe's machinery producers are grouped more or less closely around this mean figure. Two Asian manufacturing countries mark the positive and negative extremes of the sales trends.

China's mechanical engineering sector, for example, thanks to governmentally administered investment projects, managed to report a plus of no less than 10% in 2009. Japan's mechanical engineering sector, by contrast, whose product portfolio is very tightly focused on standard machines and the automotive industry, had to cope in 2008 and 2009 together with sales dropping by around 50%. In Europe, machinery sales are estimated to have shrunk in 2009 by almost a quarter, in the US by about a fifth.

Besides sales at the world's largest machinery manufactures, German machinery exports supply evidence of regional differentiation within the catastrophic overall trend in machinery exports. Exports of plant and machinery slumped in the first three quarters of 2009 by 26% in real terms, with the figures for Russia being hit particularly hard. Here, German machinery exports slumped by no less than 43%.

Exports to the rest of the EU and the USA also turned in a below-average performance, each of them down by 29%. But there are also some rays of hope, particularly in the Near and Middle East, and in East and South-East Asia. The People's Republic of China was the only one among the top 20 purchasing countries for German mechanical engineering products to report any growth, and overtook the USA early than expected as Number One in our export rankings.

Let us turn now to the outlook. Are there any signs of an end to the crisis?
The high double-figure minus in the German mechanical engineering sector's order bookings is in itself without a doubt not very encouraging. But the curve exhibited over recent months gives increasing grounds for hope. We are pretty confident that for both domestic business and export orders the downturn has ended.

The level at which these foundations are emerging, is of course, pathetically low. No historical peak figures need be adduced for this statement. The level of orders achieved in December 2009 is no less than 20% down on the average of the five-year period 2004 to 2008. To say nothing of the earnings quality these orders exhibit. But a beginning has been made. And the prospects are no longer as gloomy as they were in summer.

Important mood indicators like the OECD Leading Indicator for the Eurozone, the USA, Japan and the Major 5 of Asia have since early last year succeeded in recovering, sometimes significantly, from their historically unique nadir, thanks to bold interventions in terms of monetary and fiscal policies. Fears of setbacks, the formation of what are called expectation bubbles, as had already occurred in 2001/2002 following the attacks on the World Trade Center, have so far proven groundless.

The economic protagonists are looking at the future with a goodly portion of confidence. A majority in the guild of forecasters are predicting a lessening dynamic, but at the same time a largely stable development in the mood indicators. Fears of an imminent turnaround, a double-dip, are now being voiced only by a vanishingly small minority.

In Germany, machinery orders usually follow these early indicators with a time-lag of about 6 months. This is, mind you, a very rough approximation. But this sequential pattern appears to be confirmed even under such unusual, unique circumstances as the present ones. We need not call into question all our empirical insights - as a comparison shows between the global economic climate as ascertained by the ifo Institute in Munich and the trend in order bookings among German plant and machinery manufacturers.

And when will the recovering order bookings be reflected in turnover and production output?
It usually takes another four or five months on average until new orders show up on the shop floor. It is therefore hardly surprising that in view of the decline in sales reported so far and the extremely low utilisation levels of production capacity, almost no one in the mechanical engineering sector including myself is saying that the sector is over the worst of things.

And no one at all is willing to proclaim the beginning of a new upturn. The ongoing phase of economic development, and what we can expect in the months ahead, should in my view be described as "consolidation on thin ice".

What does the thin ice denote? Where do the risks lie?
The growth dynamic we have been seeing so far is based very considerably on governmental support initiatives. Measures that will in the majority of states be expiring in the next few months, if indeed they have not expired already- like the scrap bonus for the automotive industry. Governmental stimuli packages have admittedly averted the worst-case scenario.

The fact of a successful, international coordinated initiative is not, however, a guarantee for a no less effectively coordinated, properly dosed exit strategy that will not put more strain on the public purse than it is already enduring. We are keenly interested to see whether and how individual countries will succeed in shaping their monetary and fiscal policies so as to wind down the economic stimuli packages.

And how the economic protagonists will react to this. There are some not inconsiderable risks involved here. No matter how well-designed a governmental stimulus programme is, it cannot replace actual growth, which is essentially created by private demand and entrepreneurial action.

As a thoroughbred supplier of capital goods, you're presumably interested primarily in the companies propensity to invest, aren't you?
That´s totally right! When it comes to corporate investment, a paramount cornerstone for more robust and sustainedly strong economic development, no improvement is unfortunately discernible as yet. As far as their anticipated trends are concerned, there are substantial discrepancies among the economists at institutes and banks, particularly for investment levels, both in Germany and worldwide.

The forecasts for growth in plant and equipment investment range in Germany between 0% and an almost unimaginable 8%.

At the bottom end of the range, arguments cited include unused capacities and a comparatively young machinery stock. For rationalisation and replacement investments: either there is no demand. Or financing them will become more difficult or even impossible now that the 2009 financial year has ended, which devastated companies' figures like a hurricane. Numerous manufacturers of capital goods are still, it is argued, sitting on substantial inventories, which would constitute an obstacle to any increase in production output.

It can, moreover, be anticipated that due to rising numbers of corporate insolvencies and capacity closedowns as a result of the necessary structural adjustments, a growing number of comparatively young pre-owned machines are flooding onto the market.

At the lower end, pundits point to the successful efforts already made to cut costs. The downtrend in capacity utilisation of the existing plant has bottomed out. This is customarily followed by capital expenditure. Numerous investment projects had admittedly been shelved under total bans on expenditure, but are now being gradually reactivated. There are, it is argued, definite chances that the business cycle will in some sales regions pick up again faster and more vigorously than is widely expected.

There continues to be huge pent-up demand in the newly industrialising and developing countries. And the task of getting fit for coping with fierce international competition continues to have maximum priority worldwide. After all, as raw material prices start to rise again, the economic challenges of efficient energy production and utilisation, resource-economical, intelligent manufacturing and up-to-the-future mobility will be back on the agenda with renewed priority.

And where do you stand with your assessment?
Both lines of argumentation have something to be said for them. Probably we need not grapple with an either-or, but with a not-only-but-also. Ultimately, it will depend on whether the chances I mentioned can prove path-breaking despite the structural risks I have enumerated. It will depend how long this takes.

And it will also depend whether their contributions to growth prove to be strong enough to help cope with the accumulated structural problems involved. In view of the widespread uncertainty in our sector, with reservations extending all the way to horror scenarios, fears that for all my optimism I cannot entirely rule out, when we ourselves are cautious in our forecasting for this year of 2010.

So now what's your forecast for German machinery production output in 2010?
We are predicting, that Germany's mechanical engineering sector will in 2010 be able to more or less sustain the low production volume of the crisis year 2009, with a slight uptrend over the course of the year. This means that Germany's production output of machinery will in the first few months of 2010 still be significantly lower than in the preceding year's equivalent period. Later on the year, however, the sector may succeed in reporting plus rates again.

Disparate as this prognosis turns out to be for the course of the year, it proves to be equally disparate in the subsectors of the mechanical engineering industry. There are, both nationally and internationally, segments which, thanks to their order backlogs, have got off fairly lightly so far, but which will in 2010 suffer the full impact of the crisis.

On the other hand, there are areas which due to the severe slumps they suffered in 2009, and perhaps in 2008 as well, this year have genuine chances for growth. Not forgetting those who despite a step decline in 2009 will be facing another minus this year as well. It remains to be seen whether there are segments that are able to get through this crisis without any minus whatsoever.

All in all, the mechanical engineering sector will in the months, if indeed not years ahead, have to cope with a rather laborious process of recovery. A process with highly disparate, if indeed not contradictory developments from country to country, from customer grouping to customer grouping, from company to company.
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Author: Dr. Ralph Wiechers, VDMA

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