In a two-part blog post, we take a look at German fiscal policy—what is changing, what needs to change, and by when.
Godot might be close, but he is not around the corner quite yet. While there appears to be a bit of movement toward a more accommodative fiscal stance in Germany, for now it’s more intellectual than factual. Indeed, the Minister of Finance recently proposed another balanced budget in the Bundestag; apparently the so-called black zero
—representing Germany’s commitment to balanced budgets—is very much alive and well. However, there are two potential narratives that could shift this to becoming more concrete and explicitly expansionary: the German economy would have to deteriorate markedly from here to trigger visible countercyclical stimulus, or we would have to see a structural change in investment budgets in line with shifting government spending priorities. That said, there is a good amount of de facto stimulus possible in the near term if the budget target were actually met rather than surpassed (on average over the last four years the general government has produced a 1.3% budget surplus), and if the government were to run down the rainy-day funds that accumulated over the last few years when the economy was doing exceedingly well.
On the cyclical side, recent data offer modest green shoots: the construction PMI has bounced slightly, vehicle production also seems to be rebounding from a low base and export orders are recovering. However, the latest service PMI reading was disappointing, foreshadowing a further worsening of soft data. While the German economy might not be able to avoid a technical recession, our baseline is for positive full-year growth in 2019 followed by a moderate rebound into next year, albeit with downside risks still persisting.
On the structural side, the German capital stock has been falling for a decade. Investment budgets could be upgraded in line with government spending priorities, but many of the proposed measures that would really make a difference are not yet broadly accepted and hard to imagine under the current coalition, especially as they relate to climate measures.
The climate summit held on 20 September—wherein a German coalition government roundtable agreed on an unambitious set of measures geared at protecting the climate—should be seen as part of that switch. But, the results have fallen short of convincing both the supporters of the climate agenda and those arguing for a more expansionary fiscal stance. The package was unconvincing because the climate lobby
had been hoping for more ambitious measures on content, whereas the fiscal doves saw this as one (of many) potential turning points in the fiscal stance, as they want to spend more money no matter what.
While budgetary implications of the measures agreed upon at the summit are not clear, they are likely to be minor given the moderate size of the package
(1.5% of GDP over several years) and the fact that they could be financed from a re-prioritization of spending (rather than additional outlays). It could, however, prepare the backdrop for a sustained increase in public and private infrastructure investment over the medium term by setting the framework for a number of proposals, including CO2 pricing. In many ways, this is a good example of the German way of defining pragmatic ordo-liberalism: set the regulatory framework, and let it be complemented by market forces.
Impact on Markets/Portfolios
We expect the period through the end of this year to be full of expansionary fiscal ideas, especially if Germany indeed suffers another negative growth print in 3Q19. Expansionary fiscal headlines could potentially push bund yields higher, but the economic and political situation is such that it is hard to see a significant structural change in fiscal dynamics for now. The deficit target will continue to be (roughly) a black zero
and, leaving aside the current soft patch, the debt ratio is likely to continue on a downward trend, making a significant macro-driven extended sell-off in bunds unlikely.
Waiting for Fiscal Policy
We see scope for movement on the fiscal front in Germany, but the economic downturn would have to get worse before significant countercyclical fiscal stimulus is forthcoming. From a longer-term structural perspective, there is increasing appreciation for the role government has to play in providing a more proactive framework for (and partial financing of) infrastructure investments. But this will not amount to much in the very short run. Over the medium term, however, participation of the Green party in Germany’s federal government would likely come with a structurally higher green spending
program. However, we believe this is unlikely to happen before the next scheduled federal elections in 2021. Godot is circling.