Germany’s Debt Dilemma Tempts Finance Chief Into Bending Rules

Kamil Kowalcze
·5 min read
2

(Bloomberg) -- Germany’s finance minister plans to slam the debt brake back on this year even as he spends billions to cushion the fiscally conservative country from the energy crisis, a challenge that requires some uncharacteristic rule-bending.

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Europe’s biggest economy has had plenty of reasons to justify the decision to suspend its constitutionally enshrined limit on net new borrowing in 2020, when the bloc was engulfed by a pandemic that turned out to be only the first of a series of crises.

Three years later, with Germany flirting with recession as it pays the price of decades of dependence on cheap Russian fossil fuels, its fiscally hawkish finance chief wants the government to return to a stability culture of spending only a limited amount more than it takes in.

At issue is how Christian Lindner, who leads the business friendly Free Democrats in a coalition government with the Social Democrats and Greens, uses accounting gymnastics to reconcile restoring the debt brake with the €200 billion ($215 billion) he has unleashed to cushion businesses and households from the energy crisis.

“Yes, Germany had to exploit its financial strength, but to reintroduce the debt brake with such a show, while de facto continuing to suspend it, this hypocrisy concerns me greatly,” said Ulrike Malmendier, a member of the German Council of Economic Experts.

Data published on Friday shows the budget deficit shrank to 2.6% of output in 2022. This year it’s expected to widen again to as much as 4.5%. That would breach the European Union’s 3% cap — though it’s currently suspended and may undergo a revamp.

Lindner, who has described himself as a friendly hawk, has argued against loosening European deficit and debt rules. He campaigned on a fiscally prudent platform, and sought to block tax increases and secure protection for the debt brake in coalition talks that saw him become finance minister at the end of 2021.

He secured approval for the energy aid package in the face of competition concerns among neighbors with less fiscal firepower in 2022 while the brake was still temporarily lifted, and yet the money will mainly be spent this year and next.

This was possible through a special fund that circumvented the regular budget. Lindner has already set aside a similarly structured pot of €100 billion for Germany’s military. And he isn’t the first to use such tools, as more than 20 special funds already exist outside the budget to finance public spending.

Such a “shadow budget” is “not appropriate for a country like Germany, which values sound budgeting and transparency,” according to Malmendier, who is an economics professor at the University of California, Berkeley.

‘Right Decision’

Lindner, who comes across as a confident politician not prone to self-doubt and has staked his reputation on solid finances, acknowledges the magnitude of the decision he took.

“I openly admit the size of this borrowing did and does make me uneasy,” he told a rally of party members in Stuttgart on Jan. 6. “You don’t do it with a light step, at least I don’t. But nevertheless, it was the right decision and I stand right behind it.”

Germany must use its “economic strength so that during crisis years we don’t lose the businesses, structures and livelihoods that our country needs for the future,” he said.

Following the Covid pandemic and Russia’s invasion of Ukraine, Germany faces tough challenges. At 9.6%, inflation ended the year above the euro-zone reading of 9.2% and much higher than in neighboring France. The Bundesbank predicts consumer price rises will remain above 7% in 2023.

Private-sector activity continued to shrink in December, according to S&P Global. Analysts expect German gross domestic product to contract by 0.5% this year before resuming growth in 2024, even as recession fears have eased.

The markets are also used to a stable and reliable Germany. The yield on 10-year government bonds has risen roughly 250 basis points to about 2.15% since the Federal Finance Agency said in mid-December it would honor the plan to raise €200 billion via the so-called Economic Stabilization Fund set up in the wake of Covid.

Overall federal debt issuance will reach a record of about €539 billion this year, the agency said, sending servicing costs higher to €42.2 billion from €15.3 billion. Net new borrowing will plunge to around €45 billion from €115.4 billion in 2022, however, to meet Lindner’s pledge.

Economists argue the debt brake ensures sound public finances regardless of the parties in power.

Veronika Grimm, also a professor on the German Council of Economic Experts, said it would have been better to suspend the debt brake again than risk undermining the government’s credibility and, worse still, calling into question the rationality of the rules.

Lindner’s plans have also raised legal reservations. The Federal Court of Auditors overseeing taxpayer money has said borrowing funds in 2022 that aren’t used until 2023 and 2024 violates the constitutional principle that public revenues and expenditures have to be accounted annually.

The Constitutional Court in Karlsruhe recently backed the government’s reallocation of €60 billion of Covid funds for climate protection following a lawsuit from the conservative CDU party, but the case hasn’t been finally decided.

A ruling that addresses the handling of such special funds is expected in 2023. Lindner has said he will be watching it closely.

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