Article content

(Bloomberg) — Germany plans to unleash hundreds of billions of euros in debt-backed financing for defense and infrastructure investments in a historic shift to overhaul its notoriously tight limits on government borrowing. 

Article content

Article content

Friedrich Merz, who will likely be the next chancellor, announced late Tuesday that Europe’s biggest economy would amend the constitution to exempt defense and security outlays from limits on fiscal spending to do “whatever it takes” to defend the country. This will allow Berlin to allot essentially unlimited amounts of money to bolster its military. 

Article content

Merz’s conservative bloc and the Social Democrats of outgoing Chancellor Olaf Scholz — Germany’s main center parties — also agreed to set up a €500 billion ($528 billion) infrastructure fund for urgently-needed investments in areas including transportation, energy grids and housing. 

Why are they doing this now?

Since President Donald Trump has signaled he’ll pare back the US security presence in Europe, governments on the continent have been rushing to boost defense spending to counter the threat of Russian aggression. Trump also ordered a pause to all military aid to Ukraine, which will shift a massive burden on Kyiv’s European allies. 

The European Union separately announced a plan on Tuesday that could mobilize as much as €800 billion in additional national spending, which includes €150 billion of EU loans to member states for defense investment. 

When will Germany’s massive €500 billion fund be deployed?

The €500 billion for infrastructure spending is supposed to be ready quickly and will be stretched out over 10 years. Some €100 billion of the total amount will be allocated to Germany’s 16 states. 

Article content

Article content

The special fund will be baked into Germany’s constitution so that it doesn’t breach the country’s net borrowing limit. This so-called debt brake limits structural budget deficits to no more than 0.35% of gross domestic product, although exceptions allow for expanded borrowing during national emergencies or recessions. 

Will it be difficult to get parliament’s sign-off?

It won’t be easy but it can be done. For major decisions like changing the constitution, a two-thirds majority is required in the lower house of parliament, the Bundestag. 

That’s why Merz and the Social Democrats want to push through the vote before the newly elected parliament holds its first session in about three weeks. In the new parliament — chosen in the Feb. 23 federal ballot — the far-right Alternative for Germany and the Left party will have more than one-third of the seats. That means they will have a blocking minority on such decisions.

In order to approve the plan in parliament before the new lawmakers arrive, Merz’s Christian Democratic-led bloc and the Social Democrats will need the support of Economy Minister Robert Habeck’s Green party. It hasn’t been included in government consultations so far because they are unlikely to play a role in the next coalition, but Habeck and other party officials have in the past advocated for more debt-financed spending and a reform of the debt brake.

Article content

Will the massive investment undermine Germany’s fiscal firepower?

Germany’s sovereign debt securities, called bunds, have traditionally been scarce because the government in Berlin kept sales constrained. That’s all changed with the March 4 announcement. 

“Although bunds will now become less scarce relative to other markets, Germany will continue to have the best fiscal fundamentals, even with the large debt expansion announced last night,” said Tomasz Wieladek from T. Rowe Price International Ltd.

What does this mean for the debt brake?

It will be reformed to allow for greater flexibility, which is something that Germany’s central bank, the Bundesbank, and many economists have suggested for some time. 

But the reform might take some time because Germany will now establish an expert commission, which will draft proposals for broader rules. According to the plan announced on Tuesday, the legislative procedure should be finalized by the end of this year. 

A broader reform of the debt brake may also run into the blocking minority of the AfD and Left. 

Article content