What is the controversy over Germany’s debt brake rule? | Explained Premium

Germany's constitutional court ruled govt's move to reallocate €60B to climate fund unlawful, breaching fiscal deficit limits. The debt brake rule restricts govt from running a fiscal deficit & prohibits regions from any deficit spending. The verdict has reopened fissures in coalition, even within SPD. Germany's economy registered impressive growth & ran budget surpluses, but criticism of reticence to take advantage of ECB's policies & higher taxation to restore competitiveness was ignored. Merkel argued debt burden on shrinking young population couldn't be increased. Court verdict unclear on whether Berlin will moderate stance on fiscal rectitude as EU debates new debt & deficit rules.

The story so far: Germany’s constitutional court on November 15 ruled unlawful a government move to reallocate €60 billion, unused from the sums initially earmarked for the pandemic emergency, to a “climate and transformation fund” (KTF). The coalition government led by Chancellor Olaf Scholz’s centre-left Social Democrats (SPD) was in breach of the fiscal deficit limits enshrined in 2009 on two counts, the Karlsruhe court ruled. The first was the move to channel underutilised allocations from one sector to another and the second, the roll-over of debt from one fiscal year to the next. The judgment has reopened fissures in Mr. Scholz’s fractious coalition, even within the SPD, where divergent views have been voiced on the budget brake rule.

The debt brake rule, or the balanced budget rule, sets a cap on how much governments can borrow to finance various public projects. It restricts the federal government in Berlin from running a fiscal deficit in excess of 0.35% of Gross Domestic Product (GDP) and in effect prohibits the country’s 16 regions from any deficit spending whatsoever. The measure was enshrined into law in 2009 by the grand coalition government of the centre-right Christian Democratic Union (CDU), its sister party in the state of Bavaria the Christian Social Union (CSU) and the SPD, through an amendment to the German constitution. The budget brake is more or less the domestic version of the stringent borrowing and spending curbs built into the European Union (EU)’s Stability and Growth Pact (SGP) and the 2012 Fiscal Compact Treaty.

The plaintiffs to the dispute, the opposition CDU and CSU, contended that investments in climate change and energy transition were part of the long-term financing activities of the state. As such, these could not be funded from the emergency exemption provided in the debt brake, which was related specifically to COVID-19 relief. The government countered that the diverted money addressed the economic consequences of the pandemic, insofar as the investment shortfall could be linked to the economic impact from COVID-19.

The record has been mixed. Through successive years in the last decade, Germany’s export driven economy registered impressive rates of growth and ran budget surpluses, backed by high levels of employment compared to other states in the single currency union. Businesses borrowed cheap, thanks to the European Central Bank (ECB)’s ultra-low interest rate policies. Therefore, the government slashed net borrowing to achieve a zero-deficit budget — a scenario Berlin sold as a simple case of practising what it professed, an ideal recipe for a single currency union reeling from a sovereign debt crisis. Criticism that the biggest economy in the EU’s single currency area ought to adopt expansionary fiscal measures to cushion several countries that were reeling under a severe recession went almost unnoticed.

Come 2019, a cooling economy during a global downturn turned the spotlight on the cost of under-investment in infrastructure, viewed as critical to restore Germany’s competitiveness. Commentators and business lobbies questioned the reticence to take advantage of the ECB’s ultra-low rates of interest and expansive bond buying programme, while others pointed to higher taxation as a preferred route out of stagnant investment. Angela Merkel, then Chancellor, argued that Germany, with the world’s largest number of elderly population, could not burden its shrinking young population with additional debt. In 2020, the debt brake rule was suspended to raise record levels of borrowing to fund various pandemic measures and was on course to be reinstated this year.

It is unclear, even after the Karlsruhe verdict, whether Berlin will moderate its stance on fiscal rectitude as EU leaders deliberate new proposals to customise debt and deficit rules specific to a country’s macro-economic parameters.

The writer is Director, Strategic Initiatives, AgnoShin Technologies.