Fitch Ratings-London-11 July 2023: Germany’s proposed 2024 Budget would mark a return to compliance with the domestic debt brake rule, and should support monetary tightening to help curb inflation, Fitch Ratings says. However, envisaged spending cuts could aggravate long-term challenges related to Germany’s ageing population.
The German government approved the first draft of the 2024 Budget and financial plan through 2027 on 5 July. It plans a EUR16.6 billion (0.4% of GDP) fiscal deficit for 2024 under domestic accounting rules. This is a substantial decrease from the EUR45.6 billion (1.1% of GDP) deficit expected in 2023 and EUR116 billion (3.0% of GDP) in 2022. Between 2025-2027, the government plans to keep the deficit broadly unchanged in nominal terms.
The envisaged 2024 deficit reduction would return Germany to compliance with its debt brake rule, maintaining a commitment to sound public finances. This rule, which limits the central government’s structural budget deficit to 0.35% of GDP, has been suspended since the pandemic outbreak in 2020. The cost-cutting measures, combined with our expectation that the ECB will increase interest rates to 4.5% this year, should also help reduce persistently high inflation.
Domestic accounting rules for the debt brake calculations are based on cash-flow accounting, in contrast to accrual accounting used by Eurostat and by Fitch in its fiscal forecasts. They also exclude spending channelled via two special off-budget funds, the Economic Stabilization Fund and Armed Forces Fund, which Fitch tries to incorporate. Our most recent forecasts (pre-dating the 2024 budget) see Germany’s fiscal deficit narrowing to 1.2% of GDP in 2024 from 2.3% in 2023 (see Sovereign Data Comparator – June 2023).
Under our forecasts, Germany (AAA/Stable) would comply with the EU’s reactivated fiscal rules that cap the deficit at 3% of GDP. Our deficit forecasts also translate into a downward debt-to-GDP trajectory, with the debt ratio falling to around 64.6% by 2024 from the 2021 peak of 69.4% (AAA median at 40.6% of GDP). This is a more gradual path than pre-pandemic when the budget was in surplus and growth was more robust. Between 2012-2019, Germany’s debt-to-GDP fell by 21.2% of GDP, the third-largest reduction among EU countries after Ireland and Malta. Failure to stabilise gross general government debt over the medium term is Germany’s key negative sovereign rating sensitivity.
However, the 2024 budget also highlights the policy trade-offs many countries in the EU and elsewhere are facing in trying to reverse the pandemic’s hit to the public finances while experiencing broad-based spending pressures. It prioritises defence, with an additional EUR1.7 billion budget allocation in 2024, boosted by EUR19.2 billion (0.5% of GDP) from the EUR100 billion (2.4% of GDP) Armed Forces Fund set up after Russia’s invasion of Ukraine, meaning Germany should meet NATO’s spending target at 2% of GDP for the first time since 1991.
The 2024 budget includes spending cuts in all non-defence departments, including to Germany’s parental allowance scheme. Parents with combined gross annual income below EUR300,000 can currently receive between 65%-100% of their net salary (capped at EUR1,800) during a maximum 14 months parental leave. The 2024 budget halves the eligibility threshold to EUR150,000.
This significant cut could reduce future childbirth rates and discourage labour market participation among high-earning individuals, hindering efforts to alleviate Germany’s long-term structural challenge of an ageing population. Germany has the second-oldest EU population after Italy, with 21% of the population over 65. The European Commission’s projections show Germany’s working age population will shrink by 7.4% by 2030, pressuring economic activity and public finances.
The government decided to not further draw the Economic Stabilization Fund, created to support households and corporations during the pandemic and energy shock, of which EUR52 billion has so far been used. The budget provisions may change when parliament debates it after the summer break, ahead of its final approval by the Bundestag in December.
Source : Fitchratings