Germany: Successful Implementation of Infrastructure Investment Key to Growth, Fiscal Sustainability

* The ‘Scope Stressed’ Scenario Assumes that Annual Real Gdp Growth is 0.3pps Lower Than in the Baseline Scenario. ** an avereage for sovereigns Also Rated Aaa by Scope: Denmark, Luxembourg, Netherlands, Norway, Sweden, Switzerland. Source: IMF, Macrobond, German Federal Ministry of Finance, Scope Rathings. Fiscal Space Will Shrink Without Pension and Labour Market Reform Despite The Increase in Borrowing, Pressure to Consolidate the Federal Core Budget Will Increase Over Time. Growing Expenditures on Interest and Social Security, Including on Pensions and HealthCare, Will Reduce Fiscal Flexibility. Projected Revenue and Expenditure Trends Imply a Reduction in the Headroom of Non-Mandamental Spending to Only 3% of Total Expenditure in 2035, from 24% in 2024, Accounting. Scope Estimates An Increase In Net Interest Expenditure to 1.6% of GDP by 2030, from 1% of GDP in 2024, WHICH, WHILE REMINING FAVOROBLE COMPAED TO EURO AREA FACE, WILL REPUCE

With Limited Fiscal Headroom, German Governments Will Likely Become Even Even More Reliant on Exempions to the Exist DEBT-BRUKE RULES OR Use Special Funds More. However, Both Mechanisms Come with Significant Political Hurdles as these Decisions Require Two-Thirds Parliamentary Majorm. The Current Government Lacks Such A Majority, and Scope Believes It Will Be Increasingly Diffelt Also for Future Governments to Meet That Hurdle Given The Country.

To Create Fiscal Flexibility Over the Medium Term, Structural Reform Efforts Will Need to Focus on Pensions, Since Top-Us to The Pay-AS-YOU-YOU-GO PENSION SYSTEM INTEMTEM to EUR 116.4bn (2.3% of GDP) in 2030. Tax Revenues Could be Supported by IncreASING EMPLYMENT, INCLUDING BY INCREASING FULL-TIME EMPLYMENT AMONGNERLY.

Infrastructure spending vital to close investment gap and boosting growth The Timely Disbursomement of the EUR 500BN Infrastructure Special Fund Through Through 2035 is Critical for Germany’s Growth Tradery. To enSURE Additionality, Investment Levels in the Core Budget Will Need to be Maintained. Planned Investments Target High-Impact Projects Primarily in Road, Rail and Digital Infrastructure, Which Should Address The MOST URGENT NEEDS TO NARRROW The existting Investment Gap.

If Well Execurateded, These Investments Could Lift Germany’s Growth Potential Towards 1%. Before The Special Fund Was Announced, Scope Had Projected That Potential Growth Wuld of Decline to AUND 0.7% by the end of this decade. Neverthaless, Execution Risks Remain High, Since Many Projects Need to Be Completed in a Short Period of Time. This Could Stretch Planning and Construction Capacity But Also Lead to Higher Inflation. Investments Also Need to be Supported by Supple-Side and Labour-Market Reforms to Raise The Country’s Growth Potential Above 1% in Line with The Government’s Goal.

Germany Aims to Meet Revised Nato Target by 2029 with Uncertain Growth Effects The GOVERNMENT HAS SIGNFICANTLY RAISED ITS AMBITIONS FOR DEFENCE SPEENDING. SPEENDING Under the Nato Definition is Planned to Increase from 2.1% in 2024 to 2.4% this year and then Trend Towards 3.5% by 2029, SIX Years Ahead of The Agreed Timeline (Figure 3). As the planned Increase Affects Germany The MOST AMST AMONG EU MEMBER STATES WHEN VIEWED RELATIVED TO CENTAL GOVERNMENT REVENUS Defense spending.

But The Growth Impact Associated with Higher Defense Spending Is Likely to Be Modrate, Although That Remains Somewhat Uncertain at this Stage. The Kiel Institute Estimates that Fiscal Multipliers for Defence Spending Are Only AROUND 0.5X, DEPENDING ON THE EXTENT TO WHICH EQUIPMENT IS PROCURED DOMESTICALLY, and Howly.

Figure 3: Germany Plans to Meet Revised Nato Target of 3.5% of GDP by 2029

NATO DEFENCE SPEENDING, % OF GDP