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Scope Ratings says Germany’s central government, or the Bund (AAA/Stable), continues to support the creditworthiness of its 16 federal states (or Länder) in the Covid-19 pandemic by assuming most of the crisis’ fiscal costs.

Both the Bund and the Länder reacted forcefully to counter the effects of the crisis; direct fiscal measures in 2020 were well in excess of that other euro area economies. In accordance with emergency clauses of debt-brake laws, federal and state authorities authorised extraordinary borrowing estimated at roughly EUR 470bn (14% of GDP) for the central government and EUR 120bn (4% of GDP) for the federal state up to the end of 2022.

“The central government shouldered the costliest measures in the crisis, including Kurzarbeit (a short-time work scheme) and grants to businesses as well as discretionary stimulus spending like last year’s VAT cut,” says Julian Zimmermann, an analyst in Scope’s sovereign and public-sector team, “so pandemic costs will be significantly higher than those of the Länder.” Länder governments mostly resorted to borrowing to counteract cyclical components of their budgets, such as weaker tax revenues, and to cover direct pandemic healthcare costs. Some also implemented their own fiscal programmes but these are modest compared to the Bund’s.

“As a result, we project the central government will only return to pre-pandemic debt-to-GDP levels after 2030, significantly later than the Länder in 2023. However, we also observe significant divergence in the Länder fiscal responses and long-term debt trajectories,” Zimmermann says.

The aggregate Bund and Länder debt-to-GDP ratio is estimated to return to pre-crisis levels by 2030. This is relatively late compared to projections by major institutional forecasters such as the IMF, with the divergence being driven by more conservative assumptions in our projections.

On aggregate, a solid economic recovery will be the main driver of declining debt ratios, even if debt reduction paths vary depending on pandemic debt redemption plans and longer-term economic prospects, especially among the Länder. Redemption costs, meanwhile, will come on top of longer-term spending pressures and significant investment needs, limiting expenditure flexibility.

To fund deficit spending, debt issuance in capital markets by the German central and state governments picked up markedly in early 2020. Debt issued net of redemptions since early 2020 amounted to around EUR 350bn to mid-October 2021. The central government has remained very active in 2021 to finance ongoing stabilisation measures. By contrast, net debt issuance by the Länder has tailed off in 2021 and is stable at around EUR 70bn.

“We view the concentration of funding activity with the central government as an effective way to distribute Covid-19 costs, as the Bund benefits from larger issuance volumes and better financing conditions as a benchmark issuer compared to some of the smaller states,” explains Zimmermann. That said, larger Länder such as North-Rhine Westphalia, Lower Saxony, Berlin (AAA/Stable) and Bavaria (AAA/Stable) also tapped capital markets with significant volumes over the crisis.

Both the Bund and the Länder have maintained excellent financing conditions, with the 10-year yield consistently in negative territory for the Bund since early 2020. This mitigates risks associated with a higher debt stock post-crisis. “We expect interest costs to stay very low for the broader German general government over the coming years. However, a higher debt stock increases sensitivity to future shocks, underpinning the need for a prudent balance between closing the investment gap while supporting a debt-reduction path,” Zimmermann cautioned.