Germany suspends credit limit again after budget shock

(Bloomberg) — Germany will suspend a constitutional cap on net new borrowing for the fourth straight day after a ruling from the country’s top court forced Chancellor Olaf Scholz’s government into radical budget reform last week.

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The emergency measure to lift the so-called “debt brake” will be part of a revised budget for 2023 that Finance Minister Christian Lindner plans to present next week, a spokeswoman for his ministry said on Thursday. Due to the court ruling, Lindner must retroactively book at least 37 billion euros in new extra-budgetary debts, which are intended to relieve households and consumers from the high electricity and gas prices.

It’s a humiliating step down for the FDP leader, who insisted on restoring the borrowing cap after it was suspended for three years because of the pandemic and energy crisis, and sees himself as the guardian of Germany’s budget stability.

“With the supplementary budget, the federal government will propose a resolution to the Bundestag to declare an extraordinary emergency for 2023,” the spokeswoman said by email. The funds used to curb energy costs would be “placed on a secure legal basis” and no new debt would arise, she added.

The decline in German debt continued after Bloomberg reported earlier Thursday that the government plans to raise the borrowing limit, which would push 10-year yields up as much as six basis points to 2.62%. The premium of swaps over equivalent bonds – a key measure of supply risk – wiped out gains, leaving the spread at 52 basis points, near its lowest level since February last year.

Read more: German yields hit session highs on news of debt brake suspension

The bombshell ruling of November 15th by the Constitutional Court in Karlsruhe called into question hundreds of billions of euros in financing in federal special funds, some of which are decades old and are not part of the regular federal budget.

The Scholz administration not only dampened the effects of high energy costs, but also made funds available from various pots for initiatives, including greening production, expanding renewable energy and charging infrastructure, and subsidies for battery and semiconductor systems.

With the special funds, Lindner was initially able to fulfill its commitment to reintroduce the debt brake for the regular budget this year, while at the same time continuing to provide funds to support the restructuring of the German production base and to reduce harmful emissions.

The renewed suspension of the debt brake is the government’s second major move after it froze virtually all new spending approvals for 2023 as it assesses the broader and longer-term impact of the court ruling.

It still has to deal with the possible impact on next year’s financial plan, which was due to be presented to Parliament next week but has now been postponed indefinitely. Any action required to overhaul the special funds may also pose new legal challenges.

“We can only talk about 2024 and the next few years again when we have a legally secure, constitutionally flawless situation,” Lindner said in a short statement to reporters on Thursday. “There is now new legal clarity about how we must deal with special assets.”

What Bloomberg Economics says…

“The country’s fiscal policy outlook has become significantly more uncertain. A number of infrastructure and environmental projects may not receive funding at this time. This could reduce GDP growth by 0.5 percentage points next year, jeopardizing the gradual recovery from the downturn in 2023 and imposing significant downside risk to our 2024 forecast.”

—Martin Ademmer, economist. Click here for the full GERMANY INSIGHT

Lars Klingbeil, co-chair of Scholz’s SPD party, said on Thursday that it was “politically justified” to suspend the debt brake for this year and called for it to be lifted next year as well.

In an interview with Handelsblatt, he said the “aftermath of the pandemic”, the energy crisis, inflation, the war in Ukraine and the situation in the Middle East made it necessary.

The lending restrictions are enshrined in the German constitution, but can be temporarily suspended in the event of natural disasters or emergencies beyond the government’s control.

They have been suspended for three years until 2022 to deal with the fallout from the Covid-19 pandemic and the rise in energy costs triggered by the Russian invasion of Ukraine.

As part of the debt brake, structural net borrowing – adjusted for economic activity – is limited to 0.35% of gross domestic product. An increase in net borrowing is permitted during an economic downturn, but there is less scope for additional debt during an upswing.

– With assistance from James Hirai.

(Updates with Treasury comment from second paragraph)

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