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“The latest budget announcement reflects a momentous shift for Germany. Besides sharp increases in military spending, Russia’s war in Ukraine has brought into focus the urgency of addressing the previously identified investment needs to tackle the green energy transition,” says Eiko Sievert, director at Scope Ratings.

“Germany’s U-turn on military spending to belatedly meet its NATO commitment to spend 2% of GDP per annum on defence is an important change as is the reassessment of the country’s energy security given the dependence on oil and gas imports from Russia. Both will require sustained increases in expenditure in addition to that needed to fill the country’s investment gap and meet the growing social burden of an ageing population,” says Sievert.

Scope Ratings projects a fiscal deficit of around 6-7% of GDP in 2022, including EUR 100bn for defence spending and funds to support the transition towards a carbon-neutral economy. A further budget amendment over the coming weeks will detail additional support for households and businesses to cushion the impact from soaring energy prices.

With the debt brake suspended in 2022 due to the Covid-19 pandemic, the government plans to increase borrowing this year to a minimum EUR 199.7bn (5% of GDP). A significant portion of these funds will be held in special funds (‘Sondervermögen’) to be spent over several years. Additional borrowing in 2022 will increase Germany’s debt-to-GDP ratio by around 3 pp, partially offset by nominal GDP growth.

German federal revenues and expenditure 2008-2026F

Source: Ministry of Finance, Scope Ratings GmbH

Over the medium-term, public finances remain on a strong footing. From 69% in 2021, Scope expects debt to GDP to rise to 70% of GDP in 2022 and then fall to 62% by 2026. The government will try to reach a balanced budget in 2023 within the 0.35% of GDP structural deficit limit set by the debt brake rule instituted in 2011.

However, budget projections are inevitably subject to uncertainty surrounding the spill-over effects of the war in Ukraine, not least its impact on Germany’s economic growth.

“We have revised our forecast for real GDP growth in 2022 to 3.5%, from 4.4% previously, while, in a stressed scenario of prolonged conflict and disruptions, our projections include real growth assumptions of around 1.5% in 2022 and 1% in 2023,” says Julian Zimmermann, an analyst at Scope.

Germany is a net importer of oil, gas and coal – equivalent to EUR 93bn in imports in 2021 – so higher import prices weigh on its external balance, while an outright import shortfall, e.g. due to an embargo would reduce GDP growth by around 2.2pp in 2022, according to one recent study by Bachmann and co-authors.

“Even if the conflict doesn’t last into 2023, structural deficits at or close to 0.35% of GDP, equivalent to around EUR 15bn, would mark a significant change from pre-pandemic ‘black zero’ fiscal policy marked by average federal budget surpluses of EUR 16bn, or 0.5% of GDP, over 2014-19,” says Zimmermann.

For a round-up of Scope’s latest rating action and analysis of the unfolding crisis triggered by Russia’s invasion of Ukraine in February and its impact on European sovereigns, banks, corporate sectors and markets, please follow this link.