Is fiscal reform a turning point for the German economy?

Germany's upcoming fiscal shift could bring about a major transformation for its struggling economy as well as for European defense.

Fiscal and economic policies were once contentious issues within Germany's previous ruling coalition and contributed to its collapse late last year. Amidst ongoing negotiations to form a new governing coalition, the Christian Democratic Union/Christian Social Union (CDU/CSU) – the leading force in opinion polls in February – along with the Social Democratic Party (SPD), appear to have achieved a significant breakthrough.

On March 4th, Friedrich Merz, a potential German Chancellor, along with other political leaders, announced plans to reform Germany's long-standing fiscal regulations known as the "debt brake," aimed at increasing defense spending. They also unveiled a special fund worth 500 billion euros (approximately $535 billion) to invest in infrastructure.

Realizing these plans would require amending the German constitution, which would demand the support of a two-thirds majority in parliament . Currently, this is achievable, but it will be very difficult to achieve when the new parliament convenes for the first time later this month.

Therefore, a vote on constitutional amendments could be pushed forward as early as this week.

German people shopping at a supermarket. (Illustrative photo)

'Big, bold, unexpected - a turning point'

“Big, bold, unexpected – a turning point for the economic outlook,” economists and analysts at Bank of America Global Research wrote in a note on March 5, adding that the fiscal package would “significantly alter” Germany’s economic outlook.

Over the past few years, the German economy has been stagnant and at risk of a technical recession, defined as two consecutive quarters of declining GDP. Germany's GDP has consistently fluctuated between growth and contraction throughout 2023 and 2024.

The country is facing numerous problems, including deteriorating infrastructure, a struggling housing construction sector, and pressure on several key industries that once contributed significantly to economic growth, such as the automotive industry.

Now, there is hope for change. Experts believe that the specially planned investment fund could benefit the German economy.

Markets can expect an economic boost and growth forecasts for Germany may be raised, said Florian Schuster-Johnson, senior economist at Dezernat Zukunft, on March 5.

"I think that, in the short term, this will boost domestic demand, as there will be a great need for workers to build new infrastructure and companies will receive orders from the government," he said.

Increased defense spending could also have long-term effects on the economy, leading to increased production capacity, which could be used for civilian purposes in the future, Schuster-Johnson added.

This could help Germany surpass NATO's current defense spending target of 2% of GDP, according to economists at Deutsche Bank Research.

Friedrich Merz argues that the current geopolitical situation shows the need for major measures to strengthen the security and defense capabilities of Germany and Europe.

While these policy statements are generally beneficial, other fiscal and budgetary plans from the upcoming ruling coalition are still under discussion and could have their own impact on the German economy, according to Carsten Brzeski, Head of Global Macroeconomics at ING.

“ We do not rule out the possibility that formal coalition negotiations will still lead to some spending cuts, which could diminish the positive impact of the announced fiscal stimulus package ,” he said.

In another development, MP Bernd Baumann, a member of the far-right Alternative für Deutschland (AfD) party, said that the party is conducting a preliminary legal assessment of the government's statement and reserves the right to take countermeasures if necessary.

Policy details

In detail, the special investment fund worth 500 billion euros will not be part of the federal budget but will be financed through credit without increasing new debt. This money will be used over 10 years, focusing on transport, energy, education, civil protection, and other infrastructure. Federal states will also be allocated a portion of the fund to support their own finances.

To avoid being limited by the "debt brake" rule, this fund will be incorporated into the constitution and exempt from fiscal regulations.

Currently, the "debt brake" rule limits the amount of debt the government can borrow, and stipulates that the federal government's structural budget deficit cannot exceed 0.35% of the country's annual GDP.

A key change in the new plan is that defense spending exceeding 1% of Germany's GDP will not be counted towards the "debt brake" ceiling, meaning this spending will no longer be limited.

German states will also be allowed to borrow more than before, and long-term proposals to modernize the "debt brake" rule and increase investment will be implemented.

This proposed reform of the "debt brake" also marks a significant shift from the CDU-CSU election campaign, in which the parties repeatedly affirmed their desire to maintain the rules set during the Angela Merkel era. However, Friedrich Merz later suggested that he might be open to some reforms.

Market reaction

These plans generated a strong reaction in the market. Germany's DAX index rose 3.4% at midday on March 5 (London time), leading the gains in the pan-European Stoxx 600 index. Construction and manufacturing companies saw significant increases, as did German banks.

Germany's borrowing costs have surged. The yield on 10-year German government bonds, considered the benchmark for the Eurozone, has risen by more than 25 basis points, while the yield on 2-year bonds has increased by more than 16 basis points.

According to Florian Schuster-Johnson from Dezernat Zukunft, the market's reaction shows surprise at the speed and scale of the proposed changes.

“ The conclusion is that Germany is back and has funding ,” he said. “ The move we’ve just seen is truly remarkable. The Germans sometimes act late and are slow when it comes to making big strides, but when they do, they do it thoroughly .”

Over the past few years, the German economy has been stagnant and at risk of a technical recession, defined as two consecutive quarters of declining GDP. Germany's GDP has consistently fluctuated between growth and contraction throughout 2023 and 2024.

Source: https://congthuong.vn/thay-doi-tai-khoa-la-buoc-ngoat-cho-nen-kinh-te-duc-377011.html