German sovereign debt – a radical change of approach

Andreas Charalambous and Omiros Pissarides

We have recently written about global debt and the high levels of government borrowing, accumulated as a response to the global pandemic and aided by the prolonged period of low interest rates and subdued inflationary pressures. Although the pandemic is not expected to subside anytime soon, the general expectation is that bond markets will continue to ride a positive wave thus allowing the maintenance of historically high government debt levels.

Germany, traditionally considered a fiscally disciplined nation, warrants separate reference. The arrival of the coronavirus led, in the majority of countries, to an unprecedented mobilisation of governments and central banks. Germany has also responded decisively, in the process abandoning some of its traditional principles, including that of a balanced budget. In fact, new annual borrowing reached almost €410bn in 2020 leaving little room to question Berlin’s intentions. And in case anyone had any doubts, for 2021 the German government is planning additional bond issues totaling €470bn, extending a most unambiguous signal regarding its perception of the duration and extent of the crisis.

In addition to its importance in the context of an anti-cyclical expansionist policy, the removal of the ‘debt brake’ has benefited Germany in a way which could not be foreseen a few years back. The shift in policy from what was originally designed to keep national borrowing to predetermined levels in order to avoid chronic structural imbalances, has actually generated significant income for the German government. More specifically, with the ten-year sovereign bond yielding up to -0.6 per cent, annual revenues are expected to exceed €7bn. Within such a context, it is not difficult to understand why the temptation to stay on the path of higher debt may be more appealing than ever before.

Underlying economic fundamentals are obviously not the same in all countries. In essence, Germany is taking advantage of its long-standing adherence to an ultra-rational approach, which has allowed it to reduce government debt as a percentage of GDP from 82 per cent in 2010 to less than 60 per cent in the first months of 2020. Very few countries followed a similar policy that would enable them to possess equivalent borrowing capacity, which, even in the case of Germany, should not be regarded as unlimited. In a further sign of fiscal cautiousness, the German parliament has already pointed out the need for formulating an exit strategy in order to avoid any side effects relating to the country’s forward-looking ability to service its debt.

There can be no doubt that the approach pursued was nothing short of imperative in order to confront the pandemic. Nevertheless, even in the case of an economic powerhouse like Germany, excessive government borrowing is associated with negative connotations. Indeed, hard work will be essential over the medium term to absorb the resulting shocks – this is something to be seriously borne in mind, especially in Cyprus where the debt-to-GDP ratio, as well as the perception by the international bond markets, is noticeably not on par with that of Germany.

Andreas Charalambous is an economist and former director of the Ministry of Finance
Omiros Pissarides is the Managing Director of PricewaterhouseCoopers Investment Services