Factbox-German budget crisis tests limits of its ‘debt brake’

BERLIN (Reuters) – Germany’s constitutional court ruled last week that the coalition government’s decision to re-allocate 60 billion euros ($65 billion) of unused debt from the pandemic era to climate and industry projects was unconstitutional.

The ruling has sent budget talks into disarray and sparked calls within Chancellor Olaf Scholz’s coalition to suspend a constitutionally enshrined “debt brake” that sets legal limits on borrowing.

The government’s use of off-budget funds had been a way to comply with these limits as Germany sees itself as Europe’s strongest defender of fiscal discipline.

WHAT IS THE DEBT BRAKE AND WHY WAS IT INTRODUCED?

Introduced by then Chancellor Angela Merkel’s government through a constitutional amendment in the wake of the global financial crisis of 2008/09, the brake restricts Germany’s structural budget deficit to the equivalent of 0.35% of gross domestic product.

    The government can go beyond that if Germany is hit by a natural disaster or “exceptional emergencies” that are beyond the control of the state and significantly affect its finances. Such an exception must be declared by parliament through a majority of lawmakers.

The brake was introduced as a way to maintain sustainable public finances and avoid excessive debt in Europe’s biggest economy.

HAS GERMANY SUSPENDED ITS DEBT BRAKE BEFORE?

    The parliament suspended the brake for the first time in 2020 to help the government support companies and health systems during the COVID-19 pandemic economic fallout.

The brake was suspended again in 2022 due to lingering fallout from the pandemic as well as Russia’s invasion Ukraine, as the government grappled with higher inflation, rising interest rates and soaring energy prices.

Finance Minister Christian Lindner reimposed the debt brake in 2023 but kept a 100 billion special military fund and a 200 billion package to bring down energy costs in separate funds.

WHAT ARE THE DISADVANTAGES OF A DEBT BRAKE?

Some analysts say the debt brake is ripe for reform and a more flexible fiscal policy would let governments take on more debt to fund much-needed investments.

“The debt brake was useful in the 2010s but given the long list of structural challenges, Germany’s problem is not debt sustainability but too low growth and a worsening of international competitiveness,” said ING’s economist Carsten Brzeski.

Philippa Sigl-Gloeckner at the Dezernat Zukunft macrofinance think tank told Reuters the country’s fiscal policy had become “very short-termist” due to the constraints imposed by the debt brake.

Economy Minister Robert Habeck on Monday called the instrument “inflexible” and warned that German industry risked losing its competitiveness and would ship jobs abroad unless a way to plug the budget hole could be found.

But abolishing the debt brake would require two-thirds majorities in both chambers of parliament, a difficult task.

WHAT DOES THE COURT DECISION MEAN FOR NEXT YEAR’S BUDGET?

Last week’s court verdict has left a 60 billion euro hole in the government’s finances, and an estimated gap of about 20 billion euros to finance all projects in its Climate and Transformation fund next year.

The government is still weighing options, including suspending the debt brake or curtailing spending.