Germany rewrites its debt rules

The Bundestag has passed a constitutional amendment that loosens Germany's strict debt brake and sets up a €500 billion off-budget fund for infrastructure and modernisation, to be spent over several years. Spending on the energy transition, the railways and digital networks will no longer count towards the ordinary deficit. Berlin has, in effect, separated its big investment plans from the annual squeeze on the budget.

The package goes further than infrastructure. Defence spending above 1 per cent of GDP is exempted from the borrowing limit altogether, and the sixteen federal states gain permission to run small structural deficits of their own. The amendment still needs the approval of the Bundesrat, the chamber that represents the states, which is expected to vote within days. After two weeks of intense bargaining, the parliamentary hurdle that looked hardest has been cleared.

A race against the calendar

The vote was taken by the outgoing parliament, elected in 2021, rather than the one chosen last month. That was deliberate. In the new Bundestag the far-right Alternative for Germany and the Left party together hold more than a third of the seats, enough to block any change to the constitution. Friedrich Merz, the likely next chancellor, and his Social Democrat partners therefore pushed the amendment through before the new chamber convenes, and survived legal challenges to the timing at the constitutional court.

The Greens, whose votes were needed for a two-thirds majority, extracted a price. They secured €100 billion of the new fund for climate-related investment, and a broader definition of security spending that covers civil protection, the intelligence services and help for states under attack, which in practice means Ukraine. Mr Merz, who campaigned on fiscal prudence, ended up delivering the biggest loosening of German budget policy in a generation.

Another special fund

The new law copies the earlier special defence fund ('Sondervermögen'). It gets round the constitutional borrowing limits by creating separate borrowing vehicles that sit outside the budget. The compromise lets politicians say the debt brake still governs day-to-day spending. Bond markets were not fooled. They read it as a lasting increase in German government borrowing, aimed at rebuilding an industrial base that has been falling apart.

The history explains why Berlin reached for this device. The debt brake, adopted in 2009, caps the federal structural deficit at 0.35 per cent of GDP. The €100 billion armed-forces fund created after Russia's full-scale invasion of Ukraine in 2022 was the first large exception, and it is close to exhausted. In November 2023 the constitutional court ruled that the previous government could not repurpose €60 billion of unused pandemic borrowing for climate projects, and the budget hole that ruling left behind helped bring down Olaf Scholz's coalition last autumn. Writing the new funds directly into the constitution puts them beyond that kind of legal challenge.

How the money moves

The mechanism is simple enough. The federal finance agency will issue additional Bunds and pass the proceeds to the fund, which pays contractors, rail operators and the states for approved projects. Every euro spent through that channel adds to Germany's gross debt, which stands at a little over 60 per cent of GDP, low by the standards of France or Italy. The market's first reaction came when the plan was announced on March 4th: ten-year Bund yields posted their largest one-day rise since 1990, as investors priced in years of extra supply.

That repricing spreads well beyond Germany. Bunds anchor the euro area's yield curve, so higher German yields push up the benchmark for mortgages, corporate bonds and other governments' debt. The European Central Bank, which cut its deposit rate to 2.5 per cent this month, now has a large fiscal stimulus in its biggest economy to weigh against its plans for further easing.

Growth now, debt later

Economists' models suggest that putting half a trillion euros into domestic infrastructure will give heavy industry, construction and engineering in central Europe a sizeable boost for several years. It also means German public borrowing will stay high until the end of the decade. The need is plain enough: the economy shrank in both 2023 and 2024, the rail network is notorious for delays, and many bridges on the motorway system need replacing.

The winners are easy to name in broad terms. Builders of roads, rail and power grids, makers of cement, steel and heavy machinery, and defence contractors stand to gain order books that have not been this full in decades. Suppliers in Poland, Czechia and Austria, woven into German supply chains, should share in it. The losers are existing bondholders, who have already taken a loss on the price of their Bunds, and Germany's European partners with high debts, who now compete with a larger German borrower for investors' money even as the gap between their yields and Germany's has narrowed.

Where the plan could stall

The strongest objection is practical rather than fiscal. German infrastructure projects move slowly, tangled in planning law, lawsuits and a shortage of engineers and construction workers. If the money cannot be spent quickly, much of it will sit unused, the growth boost will be delayed, and extra demand in a stretched building sector could push up prices more than output. There is also a risk that ministries shift ordinary investment into the new fund to free room in the regular budget, which would raise borrowing without adding much new spending.

These are real limits, and they argue for patience about the growth effect. They do not change the direction of fiscal policy, which is now fixed in the constitution and cannot easily be undone. Watch the Bundesrat vote, the coalition agreement between the Christian Democrats and the Social Democrats, the federal finance agency's revised issuance plans and the first large procurement tenders. Planning reform to speed up approvals would be the surest sign that the money will actually be spent.

By writing the new funds into the constitution, Germany has abandoned the balanced budget ('Schwarze Null') in favour of borrowing to revive industry, and holders of Bunds will probably be paid higher yields for it through the rest of the decade. The first measurable effects will appear in bond issuance before they appear in output, so German borrowers will feel higher costs this year while the promised boost to construction and engineering is unlikely to show up in output before 2026.