MNI INTERVIEW: German Advisor Sees Possible Joint EU Debt Deal

Germany would be prepared to consider new joint European borrowing to boost defence in return for reforms of EU spending and state aid, with talks possible once the country’s federal budget has passed in September, the recently-appointed personal advisor to Finance Minister Lars Klingbeil told MNI.

“I can see a kind of grand bargain at the EU level that will allow for common European borrowing for defence. Meanwhile, Germany and France want more lax state aid rules. Put that together, and Portugal accepts the looser state aid rules, but also gets something in return,” Jens Suedekum said an interview.

“This is the kind of discussion we will have in the second half of the year, and I know that Minister Klingbeil is very keen that Germany should play an active role in Europe. What’s needed is a convincing story that will bring all parties together -- and defence is probably the best story there is.”

Friedrich Merz’s CDU-led coalition announced plans to spend EUR500 billion on defence and infrastructure investment earlier this year, and any question over whether the country could fall foul of EU fiscal rules was effectively dispelled by the NATO decision to commit an extra 1.5% of GDP on defence-related infrastructure, Suedekem said. (See MNI INTERVIEW: Germany Needs Favourable EU Fiscal Treatment)

“Within the German investment package there are things - such as electricity price subsidies - that are subject to EU legislation, therefore there is a conflict. From an EU perspective you cannot have a situation where Germany can subsidise whatever it wants, resulting in agglomeration around Germany. You need European cohesion. On the other hand, Brussels wants the German economy to finally grow again, because there will be spillover effects into the rest of the EU economy,” Suedekum said.

JOINT BORROWING

Joint debt-issuance to fund defence investment is - especially for countries like Italy with relatively little fiscal headroom - “simply the best solution on economic grounds,” Suedekum said. “And if there is one area where a case can be made for joint European debt it is common European defence and security.” (See MNI: Additional EU Defence-Financing Prospects Bleak)

“It would be also different to Next Generation EU, because there we had the European borrowing, but essentially it was just paid on national projects, whereas in the ideal scenario we would orchestrate the building up of European defence capacities at the European level, from Brussels. That’s something the administration will have to look at once priority number one, the Budget, is passed, and I would expect many, longer-term discussions on that issue will take place.”

Procurement would ideally be coordinated at European level to ensure that “we actually get additional tanks, not just a higher price per tank,” he said. “But this is very much a work in progress for the Defence Ministry, rather than the Finance Ministry.”

Suedekum expects Berlin’s draft Budget proposal, currently being debated by the Bundestag, to pass with only minor amendments.

Spending so much money - albeit over 12 years - will be a major demand stimulus, requiring a similarly large increase in production capacity in order to avoid adding to inflation, Suedekum said, adding that the big economic gear shift will happen in 2026, “which is when infrastructure and defence spending will really hit full steam - and indeed some institutes see growth approaching 2% next year.”

CAPACITY CONCERNS

Lack of capacity is of more concern in the defence sector than construction, where utilisation is around 70%, though Suedekum said the government’s detailed spending plan, in addition to constitutional guarantees, will ensure funds are not used for pensions and social spending, at least not at Federal level.

“There is also some concern regarding the part that goes to the Laender, because they will receive EUR100 billion from the federal government, which will then be passed on to the municipalities who are ultimately responsible for almost 40% of all public investment,” he said.

“While they are very happy to take the money, they are less willing to accept any central government guidance about how it should be spent. Even so, that doesn’t mean it’s money wasted. It will still be invested where it is needed.”