Germany’s Fiscal Policy: Careful Reintroduction of Debt Brake is Key for Investment, Growth

Striking the right balance between fiscal discipline and appropriate stimulus is vital for the next coalition government.

Germany’s debt brake is an important legal tool to support long-term fiscal discipline, though its rigid application can be a barrier to long-run investment.

The largest political parties in Germany have now published their manifestos for the September 2021 elections. If current polls prove accurate, an eventual coalition government involving the Christian Democratic Union (CDU) and Green party appears likely. This would almost certainly bring back the contentious topic of when Germany’s debt brake should be re-instated.

The current government has indicated that the debt brake, which limits federal deficits to 0.35% of GDP a year, will be suspended until 2022 but would be re-introduced from 2023 onwards. However, the budget will still need to be approved by the new Bundestag after the September elections.

Greens advocate a debt-brake review, but CDU more hesitant

The Greens advocate a review of the debt brake to allow for a substantial increase in structural investments. Current exceptionally low borrowing costs could help finance the decarbonisation of the economy, improve education and support investment in digital infrastructure through additional yearly borrowing of EUR 50bn (around 1.5% of GDP) over the next decade. However, the CDU remains committed to the debt brake in its election manifesto, rejecting any related amendments to the Constitution. Such changes would therefore be difficult to implement as they require a two-thirds majority in both chambers of parliament.

Germany still faces very low borrowing costs and has the fiscal space

Germany still faces very low borrowing costs and has the fiscal space, which could facilitate large-scale structural investments needed over the coming years despite the high costs of the pandemic.

Debt in Germany increased by EUR 273bn in 2020, reaching EUR 2.2trn (or 70% of GDP) by the end of the year. This represents the sharpest rise since German reunification, although it remains well below the debt level of around 82.5% following the great financial crisis, and significantly below that of highly-rated sovereigns such as France (AA/Stable; 116%) or the UK (AA/Negative; 104%).

The IMF, as well as the Federation of German Industry (BDI) and the German Trade Union Confederation (DGB) all advocate that Germany requires significant additional public sector investments including into its education system and digital infrastructure. A study by the German Economic Institute also illustrates longer-term underinvestment by Germany’s public sector – Germany spent USD 845 per capita each year in the period 2000-2017 and therefore remains well behind many of its European neighbours such as the Netherlands (USD 1,948), France (USD 1,628), Spain (USD 1,435), Italy (USD 1,212) and Portugal (USD 1,057).

Shift towards net zero will also necessitate the mobilisation of funds

In addition to Germany’s persistent structural underinvestment, its ambitions to shift the economy towards net zero carbon emissions before 2050 will also necessitate the significant mobilisation of public and private funds. The final cost, over which there is considerable uncertainty, ranges from around EUR 500bn to EUR 3trn, equivalent to 0.5-3% of GDP a year, according to the ifo Institute.

To support this longer-term structural transition and given Germany’s central role as Europe’s biggest economy, it is thus important that strict borrowing restrictions are not re-introduced too quickly.

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Eiko Sievert is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH.