EMU debt crisis reduces interest bill

The German fiscal budgets are receiving additional, albeit less obvious, support from the debt crisis in the euro zone. Even though Germany can be asked to contribute under the guarantees already given to Greece and possible guarantees for other EU members in the event of a default, Germany is currently profiting in concrete terms from the persistently very loose monetary policy for the entire monetary union. Despite the solid economic situation in Germany and other core countries, the situation in the peripheral countries does not
currently permit any normalization of the ECB’s interest rate policy. Bolstered by Germany’s safe-haven status within the euro zone, the public-sector budgets are facing extremely favorable terms and conditions for borrowing on capital markets. The yield of 10-year Bunds was recently under 2½%, compared to still close to 4.7% at mid-2008. The interest rate level will help lower the interest bill over the short and medium term.

Last year, the German government had to spend EUR 62.2bn on interest for the public-sector debt. The interest ratio was 2.6% of GDP, with an overall deficit of 3.1%. The average interest rate on the public-sector debt was 3.5%. New borrowing at the currently more favorable conditions will lower the average interest rate further. Based on the current debt position of roughly EUR 1.8 trillion, a 1 percentage point reduction in the average interest rate accordingly translates into a cost saving of EUR 18bn per year.


Deficit should fall below the Maastricht
ceiling as early as 2011


At the middle of last year, market expectations for the overall public-sector fiscal deficit climbed to over 6% of GDP. The starting position has, however, taken a dramatic turn for the better. The rapid economic recovery combined with the austerity measures implemented now point to a much lower deficit. In 2010, we expect the deficit of the federal government, Länder governments and local authorities to be under EUR 90bn or 3½% of GDP. In the coming year, the deficit should then already fall below the Maastricht ceiling of 3%.


Accordingly, the outlook for the debt ratio is now also much more favorable than feared only one year ago. Based on the substantially worse growth expectations at the time and without measures to consolidate the budget, calculations based on the Domar debt formula showed the debt ratio increasing to 100% of GDP by 2030. Factoring in the strong economic recovery, the consolidation measures planned to comply with the debt rule as well as temporarily more favorable financing conditions, the Maastricht ceiling for government debt of 60% of GDP could, according to the Domar Rule, already be clearly undercut by 2030.


"Bad Banks" drive debt level higher
In the short term, the debt ratio will, however, increase considerably again because of exceptional expenditures. By the end of last year, the capital which the public sector had injected into the banking sector already totaled EUR 46bn.


While this amount has not impacted the deficit statistics, the measures did have to be factored in when calculating the gross debt position12. In principle, however, the additional debt as a result of the capital stakes is matched by asset values. And in the event of a successful sale of the government’s equity stakes, the proceeds can again be used to redeem the financing contribution. The creation of the “Bad Banks” for WestLB and Hypo Real Estate has the same impact on government debt this year. In the case of WestLB EUR 77bn and in the case of Hypo Real Estate 191bn EUR in assets were transferred to government-backed Bad Banks. Overall, this will therefore increase the debt ratio by roughly 10% of GDP. After a debt ratio of 74% at the end of 2009, we therefore expect this year to bring an increase to 85% .
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