IMF calls for rethink of German debt-cutting plan if Russia halts gas flows

Germany will have to rethink plans to slash its budget deficit close to zero next year if Russia cuts off gas to Europe and the supply shock pushes the region’s largest economy into recession, the IMF has warned.

Russia has slashed exports of gas to Europe as tensions have risen between Moscow and the west over the war in Ukraine. The IMF said on Wednesday there was “a high risk that Russian gas supplies to Germany suddenly stop”, warning that Berlin’s struggle to replace all the missing gas would force it to ration supplies to heavy industrial users.

The fund estimated this disruption would wipe out as much as 3 per cent of German gross domestic product and drag the economy into recession next year.

In such a grim scenario, the IMF said Germany would face calls for “further relief measures” to support companies and households, such as maintaining the expanded Kurzarbeit furlough scheme and providing more grants to the hardest hit companies.

The cost of these extra measures meant Berlin should rethink its plans for returning to the “debt brake” next year, a policy that strictly limits its ability to take on new debts by capping the federal deficit at 0.35 per cent of GDP, the fund said.

“In a severe downside scenario, postponing the reactivation of the debt-brake rule by a year might be called for, to ensure that fiscal policy can be sufficiently supportive,” it said in its annual Article 4 assessment of the German economy, which downgraded the country’s growth forecasts.

When the Covid-19 pandemic hit Germany’s economy in 2020, the government exercised a “general escape clause” to suspend the debt brake. But finance minister Christian Lindner has said this will not be extended beyond 2022.

The German finance ministry said it would study the IMF report and “weigh up whether to implement particular proposals where circumstances allow”. 

But Lindner rejected calls from other members of the ruling coalition to suspend the debt brake again next year, telling the NTV website: “You can only do that during a catastrophe that lies outside the state’s ability to act. And precisely because we have inflation, we must comply with the debt brake.”

“Beyond that, we can’t afford debts any more, because the state itself now has a high interest burden,” he said, referring to a sharp rise in German government bond yields. “I have to assume that next year, interest costs will be €30bn. In 2021 they were €4bn.”

The IMF downgraded its forecasts for German GDP growth to 1.2 per cent this year and 0.8 per cent next year, down from 2.1 per cent and 2.7 per cent respectively in April. But it said a complete shut-off of Russian gas supplies to Europe would cut German GDP by a further 1.5 per cent this year and 2.7 per cent next year.

The fund said it expected German inflation to hit 7.7 per cent this year and 4.8 per cent next year, well above its earlier forecasts. But it warned that consumer price growth would rise by an extra 2 percentage points if Russian gas supplies stopped completely.

German officials are waiting to learn if Russian supplies via the crucial Nord Stream 1 pipeline under the Baltic Sea will resume after a 10-day maintenance period ends on Thursday.

Berlin last month triggered the second stage of its national gas emergency plan, a move that brought it a step closer to rationing supplies. The IMF said the impact of rationing would be lower if it was concentrated in the most gas-intensive areas of the economy. This would mean restricting gas supplies to sectors including: non-metallic minerals; iron, steel and non-ferrous metals; paper, pulp and printing; chemicals and petrochemicals; and food, beverages and tobacco, it added.

“The tightening of the gas market is one of the main reasons for our sharply lower growth forecasts,” said Oya Celasun, IMF deputy director and mission chief for Germany.

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