By Eiko Sievert, Sovereign and Public Sector

The collapse of Germany’s (AAA/Stable) coalition government comes at a particularly challenging time for the country amid the US (AA/Negative) election results. Chancellor Olaf Scholz intends to hold new elections by end-March, though this may happen sooner depending on the timing of a confidence vote in parliament.

Some of the adverse implications from a second Trump presidency are likely to take effect at the onset of his term in January 2025. An inability of the German government to respond swiftly to some of the forthcoming measures could heighten the country’s persistent structural vulnerabilities that have slowed growth over the past two years.

We see significant downside risks to Germany’s GDP growth, which is already projected to be weak. We estimate economic output to stagnate at -0.1% this year and continued stagnation next year with GDP growing by around 0.1%, down from our previous forecast of around 0.9% for 2025. This forecast is subject to a high degree of uncertainty depending on the scale and timing of potential trade disruptions, the expected decline in business confidence and associated investment delays, as well as the next government’s fiscal stance.

Repercussions of a Trump presidency are wide ranging
The US, Germany’s second largest trading partner after China (A/Stable) and largest single export destination, is anticipated to impose higher import tariffs, which would pose a significant setback for Germany’s export-dependent economy.

Almost 10% of German exports were destined for the US in 2023 – the highest share in more than 20 years. At the same time, the share of exports to China fell from an all-time high of 8% in 2020 to 6% in 2023, partially reflecting the increased competitiveness of China’s manufacturing sector, particularly the automotive sector.

Germany also remains highly reliant on imports from China, which accounted for 11.5% of total imports in 2023. Rising global protectionism and the increasing risk of a US-China trade war will test the resilience of German supply chains over the coming years.

Fiscal and defence policy under pressure, parliamentary fragmentation key risk

On the fiscal front, Germany is likely to face new US demands for higher military spending over the coming years, even with defence spending above the NATO target of 2% of GDP, supported by the EUR 100bn special fund created in 2022.

However, additional defence expenditure will be difficult to accommodate despite Germany’s fiscal space, with projected fiscal deficits averaging 1.2% of GDP in coming years and a debt ratio expected to fall below 60% by 2029.

This reflects Germany’s lack of budgetary flexibility due to the debt-brake provisions. The need for higher public investments, for defence but also the green transition, could result in further debates on reforms to the debt brake, the potential use of extra-budgetary funds, or shifting at least some expenditure to the European level.

However, a key risk for these potential policy shifts, which would be positive for the German and European growth outlook, is the increasing parliamentary fragmentation.

Current polls indicate that the two parties at the political extremes, Alternative for Germany (AfD) and Alliance Sahra Wagenknecht (BSW), could win around 25% of the vote. If these parties were to perform better than expected and achieve a blocking majority for constitutional changes of more than 33%, it could further complicate discussions concerning debt brake changes.

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