Investing.com - Details around the German government’s plans for spending on defense and infrastructure will likely become a major focus for investors, particularly as some experts note that the proposals could conflict with European Union rules, according to analysts at UBS.
In March, Germany moved to amend its longstanding so-called "debt brake", which had placed limits on borrowing and required German states to run structurally balanced budgets.
The changes particularly allowed for an uptick in defense expenditures, a major issue for German officials wary of a potential waning in U.S. security support and a possible threat posed by Russia. An additional 500-billion euro fund was also created for fresh infrastructure investments.
But, under the new spending, German debt could rise from around 63% of gross domestic product at the end of 2024 to a long-run level of 100% or more, research from the economic think tank Bruegel found in April. This would run counter to EU requirements for debt above 60% of GDP to eventually decline to that level.
"A key challenge for the new government will be how to implement the planned fiscal stimulus while adhering to the EU fiscal rules," the UBS analysts led by Felix Huefner said in a note to clients.
They added that while the EU can grant member states more fiscal space for defense spending through a rearmament package presented earlier this year, the exception is limited to a maximum of 1.5% of GDP. There is also no such exemption for Germany’s infrastructure initiatives, the strategists flagged.
Calculations by Bruegel found that, deploying the defense spending exemption, Germany’s additional spending space to meet the EU rules would amount to 0.2% of GDP in 2026, rising to 0.3% and 0.4% over the following two years.
However, the UBS analysts said these estimates are less than half of the fiscal stimulus that they are assuming will be deployed by Berlin.
Germany could also adjust its growth assumptions by reclassifying some of the defense spending, Bruegel has argued, although the UBS strategists argued that this would likely need more reform of EU fiscal regulations -- a process they said would be both long and "very difficult".
Regardless of how German officials may approach any disagreements with Brussels, "uncertainty about the fiscal path may increase in the months ahead, with the chance for some disappointment," the UBS analysts said. They expect Germany to outline a plan to decline its long-term debt-to-GDP ratio "either before or together with" a 2026 draft budget in the fall.