Back in October, the economy ministry was still forecasting a gain of 4.4 percent for 2021.
But a second coronavirus wave that took hold late last year and a sluggish start to vaccine rollouts across the European Union have doused hopes of a strong rebound in the early months of 2021.
Presenting the annual economic report in Berlin, Economy Minister Peter Altmaier said it would take “until the second half” of 2022 for the German economy to return to pre-pandemic levels.
“The recovery is continuing, albeit with less momentum,” said Altmaier.
“A mixed picture is emerging: while industry continues to prove robust, the
services sector is severely affected.”
Germany's gross domestic product (GDP) shrank 5.0 percent last year, the biggest decline since the 2009 financial crisis, as the pandemic swept the globe and ravaged economic activity.
The downturn was less harsh than in other large EU economies however, mainly thanks to Germany's resilient manufacturers and huge support packages from Chancellor Angela Merkel's traditionally frugal government.
Like much of Europe, Germany has been hit hard by a resurgence in Covid-19 cases in recent months, prompting officials to reimpose restrictions on public life.
The country closed restaurants, hotels, culture and leisure centres in November, followed by schools and non-essential shops in December. The measures have since been extended until mid-February.
Unlike during the first shutdowns last spring, factories have been allowed to stay open, leaving Germany's key export sector largely intact.
While the nation's coronavirus infection rate has started slowing down, the number of daily deaths remains high.
There are also concerns that new, more contagious virus variants could lead to another surge in cases, and health experts have cautioned against lifting curbs too early.
The DIW think-tank has estimated that German output could contract by as much as three percent over the first three months of 2021, after zero expansion in the fourth quarter last year.
“The German economy has a long and rocky road to go before it can return to growth,” said DIW economist Claus Michelsen.
In its report, the economy ministry said the pandemic fallout would “significantly” impact first quarter growth.
The economy “should pick up speed again” once more people have been vaccinated and restrictions are lifted, it added.
Until then, Germany will be counting on its machine makers, car manufacturers and other industrial sectors to counteract the slump seen in close-contact businesses such as hospitality, travel and retail.
Industrial orders jumped 2.3 percent in November month-on-month, the latest
data from federal statistics agency Destatis showed, while factory output rose 0.9 percent.
Both indicators have been rising for several months, powered by demand from China where the virus has been largely contained.
But the picture is bleaker for firms at the sharp end of the restrictions.
The German Retail Association (HDE) has warned of a looming wave of bankruptcies that could see up to 50,000 stores close down in the months ahead.
In small- and medium-sized business, often ranked as the backbone of the German economy, more than a million jobs are at risk, according to the KfW public development bank.
Merkel's government has over the past year unveiled over a trillion euros
in rescue and stimulus funds to cushion the pandemic shock, ditching its cherished no-new-debt rule to do so.
Airline giant Lufthansa and tour operator TUI are among those that have tapped the government for state aid, and millions of Germans are on subsidised short-time work schemes.
But many businesses have also complained the financial assistance has been slow to arrive and that calculation rules have changed to their disadvantage in January.
The economy ministry said the government would “continue to support companies through this difficult time”, but the increase in public spending would be “more moderate” than last year.
Unemployment is expected to nudge down from 5.9 percent in 2020 to 5.8 percent, it added.
Altmaier said Germany should use the crisis to become more competitive, with a focus on skilled workers, digitisation and climate change.
Looking further ahead, Berlin has previously said it expects Germany's economy to grow 2.5 percent in 2022.