Why is Germany’s budget in crisis and what are the implications?

By Holger Hansen and Sarah Marsh

BERLIN (Reuters) – Germany’s constitutional court ruled last week that the coalition government’s decision to reallocate 60 billion euros ($65.21 billion) of unused debt from the pandemic era to its climate and transformation fund (CTF) was unconstitutional.

The ruling, however, potentially also affects other off-budget funds that the country has used over the years to finance government policy in order to comply with its self-imposed debt brake restricting the public deficit to 0.35% of GDP.

Here are some of the implications for the budget, the economy, German fiscal policy and Chancellor Olaf Scholz’s three-way coalition:

WHAT COMES NEXT FOR THE 2024 BUDGET?

The ruling did not directly impact the regular 2024 budget, which is due to be voted on by parliament on Dec. 1.

Still, it means there is a funding gap for projects that were due to be covered by the CTF and other funds that may be affected by the ruling – both this year and next.

If you consider, for example, that the annulled CTF funds were due to be spent by 2027 that implies a gap in funding of about 10-20 billion euros per year, according to Scope Ratings.

As such, Scholz’s coalition of his Social Democrats (SPD), the Greens and the Free Democrats (FDP) could end up making alterations to next year’s budget, currently amounting to 446 billion euros.

The government looks set to postpone talks planned for Thursday on the 2024 budget as it struggles to figure out solutions.

Some politicians from the fiscally hawkish FDP have argued in favour of cutting some social expenditure – a move to which the centre-left SPD and Greens object.

The government currently looks likely to suspend its debt brake for 2023, five government sources told Reuters. That however does not necessarily account for the funding gap next year and it is unclear if the government might suspend the brake again.

Germany can suspend the debt brake if it is hit by a natural disaster or “exceptional emergencies” that are beyond the control of the state and significantly affect its finances. The question is whether the current circumstances can be considered an “exceptional emergency” – and whether or not the FDP agrees to a suspension.

WHAT PROJECTS ARE IN JEOPARDY?

The government has been relying on the CTF to finance much of its agenda to support industry, keep it competitive and transition towards a carbon neutral economy.

German industrial projects in jeopardy from the blow to the CTF include chip factories, decarbonised steel production and expansion of the battery supply chain, according to government sources.

Projects that had been expecting state support include a planned TSMC chip plant, an expansion of an Infineon (OTC:) plant in Dresden and an Intel (NASDAQ:) plant planned for Magdeburg.

WHAT CAN HAPPEN WITH OTHER SPECIAL FUNDS?

There are currently 29 special funds at the federal level, with a total volume of 869 billion euros, according to the independent auditing institution Bundesrechnungshof.

Several of these could be at risk from last week’s verdict although it is still not clear which, with the exception of the 100-billion special fund for Germany’s army that is covered by a separate constitutional exemption from the debt brake.

Berlin has blocked spending from the 200-billion euro Economic Stabilisation Fund for this year and wants to close it by year-end, a government source told Reuters on Tuesday.

HOW WILL IT AFFECT GERMAN FINANCIAL POLICY?

Germany has in the past few years used what some analysts call accountancy tricks to get around its debt brake, which it introduced in the wake of the global financial crisis of 2008/09 to avoid excessive debt.

The ruling indicates that Berlin will in the future have to stick more closely to the spirit of the brake – or reform it altogether.

“The debt brake in its current form is not suitable for the challenges of the future, as the constitutional court ruling … has shown,” said the leaders of the SPD parliamentary groups in the Bundestag lower house, European Parliament and states.

WHAT ARE THE CONSEQUENCES FOR THE GERMAN ECONOMY?

The ruling and its fallout could drag economic growth down by as much as half a percentage point next year, an economy ministry source told Reuters on Friday. Last month, the economy ministry predicted 1.3% growth for next year.

In the long-term, the 60-billion euro hole will make structural changes harder and hence increases the likelihood of a longer stagnation, ING’s economist Carsten Brzeski said.

Scope Ratings said it already estimated German under-investment at around 300 billion euros over the past decade vis-à-vis other AAA-rating economies.

WHAT WILL BE THE IMPACT ON RULING COALITION?

The ruling has already heightened tensions in Scholz’s fractious three-way coalition, which has seen support slump since taking office nearly two years ago as it tackles a series of crises, in part due to public infighting.

Just a third of voters would vote for the parties of the coalition if an election were to be held now, according to the latest survey by pollster Forsa. And some politicians from the coalition parties say they are not sure it makes sense for it to them to continue governing together.

But the parties are likely to hammer out a compromise no matter how great their divisions, analysts say, because they would all stand to lose from a fresh election, and no workable new majority appears possible in the current parliament.

Other coalitions have also faced speculation they would fall apart, say analysts, but the last time one did was in 1982, when SPD leader Willy Brandt was forced to resign after a close aide was exposed as a spy for Communist East Germany.