Germany's Budgetary Crisis Threatens Europe
But also — European elections, Electricity networks, inflation
Hi! It’s Wednesday, 6 December 2023, and here’s the EU news you need this week. Feel free to share this newsletter with friends and colleagues, and follow us on Twitter and Linkedin.
The Briefing
Two weeks after the political earthquake caused by the German Federal Constitutional Court’s (Karlsruhe) ruling on the German budget, uncertainty remains regarding how the ruling coalition plans to resolve the situation. The consequences of this crisis on European economic governance are substantial.
DAS BUDGET • At the heart of the political and budgetary crisis that Germany has been experiencing since mid-November is a decision by the Karlsruhe Court. The Court sided with 197 CDU/CSU members of the Bundestag who argued that Olaf Scholz's government had illegally reallocated €60 billion from unspent Covid-19 emergency funds to the Climate and Transformation Fund (KTF).
The court deemed the reallocation unconstitutional, stating that emergency funds can only be reallocated to address emergency situations.
The Climate and Transformation Fund, initially endowed with a total of €212 billion, is now missing €60 billion following this judgement.
KATASTROPHE • Currently, it is difficult to predict how the coalition will navigate this situation. Karlsruhe's decision deals a significant blow to the ruling coalition, which includes the Greens, FDP, and Olaf Scholz's SPD.
The reallocation of unspent Covid-19 funds to the climate fund had facilitated the coalition agreement in December 2021. This accounting manoeuvre aimed to satisfy the FDP's budget discipline and the Greens' desire for Germany to contribute financially to its environmental ambitions.
EU BUDGET • The shockwaves from the German Constitutional Court's decision are being felt in Brussels.
Germany has toughened its stance on a potential top-up of the EU budget. In June, Member States rejected the European Commission's request to increase the EU budget by €66 billion for the period 2021-2027, asking the Commission to revise it downward (about 20%).
The issue will be on the agenda of the next European Council meeting on December 14 and 15. According to Johannes Hahn, European Commissioner for the Budget, "the biggest problem is that Germany is so distracted by domestic problems that they literally don’t find time to address this issue."
SGP • The reform of European budget rules is also affected by the German budgetary crisis.
These rules — contained in the Stability and Growth Pact (SGP) — were temporarily suspended due to Covid-19. In 2020, the general derogation clause of the Pact was activated to lift these obligations in order to deal with the health crisis and avoid subjecting a Member State to excessive deficit procedures.
Due to the war in Ukraine and the current energy crisis, the derogation clause has been extended and is expected to last until the end of 2023, after which the Commission hopes for a revised SGP.
In April 2023, the European Commission presented its reform proposal, aiming for more flexible rules tailored to each country, moving away from the "one-size-fits-all" approach. The 3% deficit and 60% public debt rule would be kept, but the Commission would give more time and flexibility to Member States exceeding these thresholds to restore order to their finances.
As negotiations between Member States on the Commission's proposal enter their final phase, several issues remain unresolved. The appropriate level of deficit reduction is the main point of contention within the Council, potentially preventing Member States from reaching an agreement by the end of the year.
Since the start of negotiations, Germany has been skeptical of the Commission's more flexible approach. Moreover, Berlin seeks stricter budgetary adjustments than envisaged when a state's deficit exceeds 3% of GDP. Karlsruhe's decision undermines Germany's credibility on budgetary matters, making it tricky for Germany to justify its calls for stricter budget rules since it is violating its own national rules.
However, it is unlikely that Germany will change its position on the reform. The issue is on the agenda of the next Economic and Financial Affairs Council meeting on December 8.
INVESTMENTS • The consequences of Karlsruhe's decision could also be felt in the European economy. Despite fears of a recession in 2023, Germany remains the largest economy in the EU.
A sudden reduction in German public spending could have a negative impact on the rest of the EU at a time when investments in energy transition are crucial to compete with China and the United States.
The long-term effects of Germany's very strict budget rules — since 2009, the German Basic Law has prohibited a public deficit exceeding 0.35% of GDP — are also a major concern for the European economy. Since 2009, these rules have limited German investments in key sectors.
"With one of the lowest growth rates in the Eurozone and declining competitiveness, Berlin now serves as a prime example of the ruinous consequences of withholding strategic investments," notes Philipp Lausberg from the European Policy Centre.
BAD LOOKS • Politically, this is also a setback for Germans, only a year and a half after the start of the Russian invasion of Ukraine, which revealed the flaws of Germany’s energy policy.
On November 22, during a press conference, a journalist even asked Giorgia Meloni if she still considered Germany a reliable partner. "Very reliable," she replied."
In Case You Missed It
ELECTIONS • According to polls, the far-right Identity and Democracy (ID) group could make a significant breakthrough in the European elections of June 2024. Estimates would see ID winning between 85 and 87 seats, potentially surpassing the European Conservatives and Reformists (ECR) and/or the liberals of Renew Europe to become the third or fourth biggest political group in the Parliament.
During an event organised by Politico, Manfred Weber, leader of the European People's Party group (the most represented in Parliament with 181 seats), sounded the alarm. The German MEP believes it is necessary to address migration to prevent a strong rise of the far right in the upcoming elections.
"If we cannot limit the number of arrivals until June next year, then the European elections will be a historic vote for the future of Europe, because then extremists from left and right … will benefit", Manfred Weber said.
In the Netherlands, a number of political analysts have linked Geert Wilders' resounding victory in the parliamentary elections to the VDD's (the party of the current Prime Minister Mark Rutte) failed strategy of allowing immigration to take center stage during the campaign. Weber disagrees: "The reception centres in Belgium, in Germany, in Austria and the Netherlands are full. You cannot avoid having a debate about this."
Also present at this event, the President of the European Commission, Ursula von der Leyen, announced that she would "keep the direction of travel" if chosen for a second mandate. She has not yet mentioned whether she is considering a candidacy for a second term.
ELECTRICITY NETWORKS • On November 28, the European Commission presented its action plan to strengthen electricity networks in order to enhance their capacity to accommodate a growing amount of electricity. The Commission estimates that electricity consumption will increase by 60% by 2030.
The increase in the share of renewable energy in the European energy mix is a leading factor for the rise in electricity consumption. Through the revised Renewable Energy Directive (RED III), the EU aims to increase the share of renewable energy in the EU’s final energy consumption to 42.5% by 2030, compared to 22% at the moment.
To achieve this, the Commission estimates that €584 billion in investments in electricity networks will be needed by 2030. The goal is to accelerate the development of networks, make them more digitised and decentralised, and renovate existing infrastructures — 40% of the EU's electricity networks are over 40 years old.
The stakes are high: currently, reinforcement waiting times for networks range from 4 to 10 years, and from 8 to 10 years for high-voltage networks. For investors, these delays create uncertainty that can sometimes lead electricity generation projects being dropped.
How can we facilitate these investments? According to its action plan, the Commission aims to accelerate the implementation of Projects of Common Interest (PCIs) which benefit from simplified regulatory conditions.
While the Commission does not plan to create a dedicated fund, it will explore the need for new investment tools with the European Investment Bank (EIB) and increase the visibility of existing funds: electricity networks are eligible for financing through regional funds (FEDER), cohesion funds, and the Recovery and Resilience Facility (RRF), including its REPowerEU component — among others.
Leo Birnbaum, the president of Eurelectric, considers that the Commission's plan is an "excellent first step." However, "Europe’s grids face an escalating number of threats from more frequent extreme weather events. This Action Plan should therefore acknowledge the need for more climate adaptation measure to make our infrastructure more resilient to climate change."
INFLATION • In November, the annual inflation rate in the eurozone dropped to 2.4% — the lowest level since July 2021 — compared to 2.9% in October, according to the latest Eurostat data.
This significant drop is more pronounced than the 2.7% expected by economists surveyed by Reuters for November. This intensifies debates about the possibility of an imminent interest rate cut by the European Central Bank (ECB), as anticipated by markets.
Christine Lagarde indicated on November 21 that it was too early to "declare victory," and that inflationary pressures caused by wage increases "remained strong." The ECB president also noted that it was not off the cards that overall inflation (which includes energy and food price variations) could increase in the coming months, due to a possible rise in energy prices.
What we’ve been reading
Matthias Bauer from ECIPE strongly criticises what he sees as a protectionist turn by the European Union.
Europe should not be alarmed by the Chinese origin of critical minerals, argues Jacob Funk Kirkegaard of the Peterson Institute.
In a column for Bruegel, Marek Dabrowski highlights the economic challenges that a new post-PiS government in Poland will have to face.
This week’s newsletter is brought to you by Hana Rajabally, Maxence de La Rochère and Augustin Bourleaud.