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IF Insights: What’s next for Germany as country enters recession

IFM_Germany Recession
Germany's expected interest costs for 2023 are €39.9 billion, a tenfold rise from the €3.9 billion it had to pay in interest for its debt in 2021

For the first time in almost a decade, Europe’s largest economy is experiencing money problems, and it’s up to three quarrelling parties to resolve them.

According to official data, Germany officially entered a recession on May 2023, with economic output declining by 0.3% in the first quarter of the year, the second consecutive quarter with declining gross domestic product. Lower consumer expenditure due to rising prices and a neck-breaking 7.2% inflation was blamed for the decline.

This increases the pressure on the Olaf Schloz government’s coalition partners to reduce spending. That necessitates difficult choices, but their strategies differ significantly. The business-friendly Free Democrats (FDP), who want deregulation, oppose the ecological Greens’ proposal to fund further investments in climate protection by taxing the wealthy.

Quarrel Within The Government

Caught in the middle, Chancellor Scholz’s Social Democrats hope that investing in new, green industries and luring skilled foreign labour will spur the European country’s economic growth, though it’s unclear how.

Not everyone, however, shares Scholz’s optimism. Vice Chancellor and Minister of the Economy, Robert Habeck of the Greens, warned that Europe’s largest economy could face budget cuts of up to €22 billion in 2024.

The government budget is shrinking for the first time in many years, and Habeck noted that “the entire system is not attuned to it.”

Fighting inside the ruling coalition, over a contentious ban on oil and gas heating in households, that has brought Germany to the verge of a political crisis, would further exacerbate efforts to alleviate the nation’s fiscal troubles. Berlin had to make such complex budget cut decisions in 2014 following the global financial crisis, when only the Social Democrats and Angela Merkel’s conservative CDU/CSU were in power.

Christian Lindner, the finance minister and leader of the FDP, warned that the government needed to get ready for “challenging” budget negotiations while promoting economic growth by reducing red tape, attracting more investment, and hiring skilled workers.

He cautioned that failing to do so could put Germany in “danger” of falling behind its rivals on the world stage.

Due to their reliance on the robust performance of Germany’s extensive industries, the eurozone and the rest of the European Union are also in trouble if the country enters a recession.

According to Christian Lindner and his FDP, Germany’s only option is to reduce spending. He estimated that the economy would have adverse effects from the Ukraine crisis, such as higher energy costs and decreased investment rates, over the coming years, thus resulting in a shortfall of €30 billion in tax revenue. Moreover, the government has no reason to believe that tax revenue will soon grow again in light of the reports of an economic slowdown.

Rising interest rates, which are reducing the remaining financial room for manoeuvre, are another significant issue. Germany’s expected interest costs for 2023 are €39.9 billion, a tenfold rise from the €3.9 billion it had to pay in interest for its debt in 2021.

Christian Lindner said, “For a very long time, we lived extremely well on artificially low-interest rates. Now we have the task of returning to good public finances and their long-term sustainability in a very different economic context and in a very different interest-rate environment.”

Since forming the three-party government in 2021, Scholz has been able to resolve funding disputes by creating special funds that lie outside the regular budget, including a controversial €200 billion pot of cash to lower gas and energy prices for citizens and companies, as well as a €60 billion climate fund to help meet environmental goals. However, the parties are reluctant to contribute to these so-called “shadow budgets,” which totalled a staggering €360 billion in 2022, or 75% of 2023’s regular budget of €476 billion.

Various ministries have yet to be particularly willing to reduce expenses. Instead, they have requested an additional €70 billion for the following year to cover a variety of special requests, including more funding for child support and climate protection and other funds to modernize Germany’s armed forces and meet NATO’s 2% defence spending target.

Scholz’s Social Democrats’ budget spokesman Dennis Rohde said, “This will be the most challenging budget in ten years.”

According to Sven-Christian Kindler, his Green Party colleague, the government should spend more money on climate protection. However, this spending should be paid for “via a stronger, fairer tax policy that places greater responsibility on the wealthiest,” he added.

Sven-Christian Kindler acknowledged that Christian Lindner had opposed such tax rises, saying that “the finance minister is not a supporter of these measures.”

The FDP’s budget spokesman, Otto Fricke, maintained that despite the reduction, the projected budget for 2024 would still be significantly greater than previous budgets before the COVID outbreak. The economic development of the preceding few years had allowed Germany to expand its regular budget.

The spending for 2024 would be USD 60 billion more than the pre-crisis budget for 2020, he said, noting that there are currently plans for about 420 billion euros. It had previously taken ten years for such growth.

Conclusion

The three parties in the Berlin government’s coalition are quarrelling over how to reduce spending to alleviate the nation’s fiscal troubles. The significant issues are the rising interest rates, reducing the remaining financial room for manoeuvring, and ministries’ reluctance to reduce expenses. The projected budget for the following year would still be significantly greater than previous budgets before the COVID outbreak, but this would be the most challenging budget in ten years.

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