Special funds reduce budget transparency; Debt ratio down
Germany retains significant fiscal space with a lower debt-to-GDP outlook in the medium term. However, the central government’s financial flexibility is constitutionally limited by so-called debt relief. The debt brake limits structural central government deficits to 0.35% of GDP, or about €15 billion per year.
By increasingly using special funds, which are exempt from state debt brake provisions, for spending in key areas of state responsibility, such as supporting the green transition and military spending, the government is reducing the visibility of public spending just as the economy navigates a surprisingly slow post-Covid recovery.
German economy finds itself on the slow lane
Germany is the only AAA-rated state whose economy has yet to reach pre-pandemic production levels (Figure 1) and, given a likely significant slowdown in the second quarter, it may not reach such a pre-pandemic threshold until late 2022.
Figure 1. Real GDP levels of AAA-rated sovereigns
2019Q4 = 100
In response to the escalating Russian-Ukrainian war, the government intends to dramatically increase military spending. Parliament approved a special military fund on June 3 with the support of the opposition Christian Democratic Union/Christian Social Union to enshrine the fund in the constitution.
Additional borrowing of €100 billion, or about 3% of GDP, with repayments starting in 2031, will be excluded from the debt brake’s deficit limitation calculations.
The move is just the latest in a series of measures that would circumvent debt brake limitations over the next few years, totaling around €212 billion (6% of GDP) in value.
The objective of respecting the debt brake from 2023 promises to be ambitious
The government’s objective of complying with the debt brake from 2023 appears ambitious. Berlin will likely face additional spending needs on top of the additional investments needed for energy transition, digitalization as well as social security, including the accommodation and integration of over 800,000 Ukrainian refugees hosted by Germany. . As a result, we project a general government deficit of 4.5% of GDP this year and 2.9% for next year, and general government deficits above 1% of GDP until 2025.
Additional funds are also needed to fill Germany’s large investment gap. We previously estimated this discrepancy at around 410 billion euros. As demographic pressures reduce Germany’s growth potential over the next decade, it is important that additional funds are directed, where possible, to growth-enhancing investments.
In the short term, the German recovery is being held back by supply chain disruptions and high inflation
In the short term, Germany’s recovery from the pandemic is being held back by supply chain disruption and rising prices, both of which are exacerbated by an ongoing Russian-Ukrainian war. Producer prices increased by 34% year-on-year in April 2022, mainly due to high input prices of electricity, gas and crude oil, but also base metals and chemicals, while Germans are cutting back on consumer spending due to a sizable loss of real disposable income this year. .
We therefore expect real GDP to grow only 2.3% in 2022, half the rate we expected for this year in December 2021. Significant downside risk remains, including the risk of Russian counter-sanctions leading to a interruption of the flow of gas to Germany before a situation currently envisaged. the elimination of Russian gas is complete. China’s zero Covid policy and trade disruptions are also expected to dampen export performance.
That said, German general government debt levels will gradually decline from an expected 72% of GDP in 2022 to around 65% by 2027, despite increased use of special funds and slower economic growth than economies. AAA-rated German sovereign peers.
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Eiko Sievert is Head of Sovereign and Public Sector Ratings at Scope Ratings GmbH. Julien ZimmermanSenior Sovereign and Public Sector Rating Analyst at Scope Ratings, contributed to this commentary.
This article originally appeared on FX Empire