Germany has long championed strict budget rules within the EU — pushing to inflict pain on straying members. Now that Berlin needs to go on a spending drive, however, it wants them looser.
Finance minister Lars Klingbeil, a Social Democrat who will meet his European counterparts for the first time on Monday, has a mandate to deploy billions into Germany’s armed forces and infrastructure, part of a €1tn stimulus plan by conservative chancellor Friedrich Merz to re-arm and revive the Eurozone’s largest economy.
But while it has lifted its own national borrowing caps to spend the money, Berlin is expected to fall foul of limits it has helped design at the EU level, even when taking account of Brussels’ recent easing of fiscal rules for defence, according to analysts and Germany’s internal assessment.
The looming breach — and subsequent wrangling with Brussels over corrective measures — underlines how the fiscal step-change in Germany, which is on a spending path unseen since reunification, is rippling through the EU and raising questions over the merits of rules not even their champion abides by.
“It is an irony that Germany has been Europe’s disciplinarian for years and now wants to relax the rules,” said HEC professor Armin Steinbach. “Recalling the debt crisis, much of the tension in Europe had to do with Germany insisting on rule compliance.
“It shows that the rules are unfit for the geopolitical age,” he added.
Under the so-called Stability and Growth Pact, EU members must keep their budget deficit within 3 per cent of GDP and public debt below 60 per cent of GDP.
Germany’s debt ratio stands at 62 per cent while lower tax receipts are expected to widen the deficit. Economists have suggested debt could rise to about 80 per cent of GDP over the next years.
The rules, designed in the late 1990s, have a haphazard history of enforcement — with both Paris and Berlin falling foul of them in the early 2000s without incurring sanctions.
After a four-year hiatus during the Covid-19 pandemic, they came back into force after another tightening, largely driven by the former German finance minister Christian Lindner, whose sacking in November by then-chancellor Olaf Scholz paved the way for early elections.
The ramifications of Germany’s new fiscal thinking for the EU emerged as early as March, when German ambassador Michael Clauss requested an exemption for defence spending.
Berlin’s U-turn surprised traditional EU fiscal hawks such as the Netherlands, which have relied on Germany to uphold discipline throughout the bloc. It also caught off guard the countries that battled with Germany’s intransigence during years of negotiations, according to two people present at the March ambassadors’ meeting, at which Clauss made the request.
The envoy from one such country remarked, tongue-in-cheek, that the German request should be assessed with “debt sustainability” in mind — a long-held Berlin leitmotif — the officials said.
The European Commission was quick to meet Germany’s demands: a so-called national escape clause will allow countries to spend up to 1.5 per cent of GDP on average over four years on defence-related expenditure, without incurring punitive measures.
“Germany called, Brussels abided,” said one EU diplomat.
Berlin’s move has gained widespread support, however, because the revised rules — alongside a €150bn defence loans package that Brussels offered at the same time — are seen as instrumental in helping EU members meet higher Nato defence spending requirements. Sixteen EU members have since asked to use the exemption, including Germany, Poland, the Baltic states, Denmark and Finland.
France is a notable exception. A recent increase in borrowing costs has led Paris, whose debt-to-GDP ratio stands at 113 per cent and whose deficit is forecast to reach 5.4 per cent this year, to stick to budget discipline. “Reducing the deficit is a priority for us, not just to comply with [EU Stability and Growth Pact] rules,” a French official said.
But the national escape clause does not solve Berlin’s problem. It is still expected to breach EU rules the moment it starts spending its €500bn infrastructure fund, according to research by think-tank Bruegel.
In the weeks before Merz’s coalition with the Social Democrats took office, former German finance minister Jörg Kukies had sought to widen the scope of defence expenditure eligible for the exemption, without much success, two people with knowledge of the efforts.
Now, Klingbeil, who is due to submit a medium-term budget forecast to the commission before summer, is planning to argue that Germany’s spending programme will boost growth in Europe’s biggest economy.
Beyond the technical discussion over what could be included in the defence exemption, Berlin is hoping that commission president Ursula von der Leyen will recognise the merits of her home country stimulating its economy amid a burgeoning trade war with the US and growing geopolitical challenges, the people also said.
The German finance ministry said that “the fiscal starting position and growth potential are decisive factors” with regards to discussions with the commission. The ministry is also planning to highlight the structural reforms outlined in Germany’s coalition agreement, they added.
“The aim of the investment offensive planned by the Federal Government is precisely to strengthen growth,” they said.
This strategy will offer limited additional fiscal leeway, however, according to Steinbach. “The need to ramp up defence, industrial policy and infrastructure require an update of the rules,” he said.
But yet another reform of the rules can also open a “Pandora’s box”.
“Many EU countries sit already on a mountain of debt and cannot afford higher debt levels. What is needed is a targeted reform and the right mix of national and EU debt,” Steinbach said.
