Council Opinion of  14 March 2006  on the updated stability programme of Germany, 2005-2009
Date: 2006-03-14
Institutions: Council of the European Union
Subjects: Germany, budget estimate, economic forecasting, public finance, stability programme

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COUNCIL OPINION

of 14 March 2006

on the updated stability programme of Germany, 2005-2009

(2006/C 82/02)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveil-
lance of budgetary positions and the surveillance and coordination of economic policies (1), and in particu-
lar Article 5(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1)

On 14 March 2006 the Council examined the updated stability programme of Germany.

(2)

(3)

GDP growth in the last ten years was 1,4 % p.a., trailing the euro-area average by more than half a
percentage point. The growth potential has been steadily declining throughout this period. Activity,
while being driven by buoyant exports, was held back by sluggish domestic demand. From an
extended stagnation in the early part of the decade, demand and real GDP peaked shortly in 2000
and also in 2004, but weakened again thereafter. With employment creation also subdued, the
unemployment rate rose to 9,5 % of the labour force. The general government deficit breached the
3 % of GDP Treaty reference value for the fourth consecutive year in 2005. Public debt, having been
close to 40 % of GDP in 1991, has been exceeding the 60 % of GDP Treaty reference value since
2002.

On 21 January 2003, the Council decided that an excessive deficit existed in Germany, and recom-
mended, based on Article 104(7), that the excessive deficit be corrected by 2004. In its Communica-
tion to the Council of December 2004 on ‘the situation of Germany and France in relation to their
obligations under the excessive deficit procedure following the judgement of the Court of Justice’,
the Commission concluded that 2005 should be considered as the relevant deadline for the correc-
tion. In January 2005, the Council concurred with this view. On 14 March 2006, the Council
decided to give notice to Germany in accordance with Article 104(9) to take measures to remedy
the situation of excessive deficit by 2007. In its opinion of 17 February 2005 on the December
2004 update of the stability programme, covering the period 2004-2008, the Council
invited
Germany: to do the necessary to ensure the correction of the excessive deficit in 2005; to implement
budgetary adjustments in the years beyond 2005 and make the necessary effort in structural terms
to achieve a budgetary position of close to balance by the end of the period covered by the
programme; and to continue with structural reforms in order to further improve the long-term
sustainability of public finances in particular as regards the health care system.

(4)

According to data provided by Eurostat, the general government deficit in Germany amounted to
3,3 % of GDP in 2005. These data, pending a further assessment of their quality, are based upon a
provisional notification from Germany pursuant to Council Regulation (EC) No 3605/93, which
Germany submitted to the Commission on 24 February 2006. The previous update of the stability
programme had set a target of 2,9 % of GDP for 2005.

(1) OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The

documents referred to in this text can be found at the following website:
http://europa.eu.int/comm/economy_finance/about/activities/sgp/main_en.htm

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(5)

(6)

(7)

(8)

(9)

(10)

The German stability programme update was submitted on 22 February 2006. The programme
covers the period from 2005 to 2009. The programme broadly follows the model structure for
stability and convergence programmes specified in the new code of conduct (1).

The macroeconomic scenario underlying the programme envisages that real GDP growth will pick
up from 0,9 % in 2005 to 1,4 % in 2006, with domestic demand gaining momentum. After a slow-
down to 1 % in 2007, growth is set to resume thereafter, yielding an average growth rate of 1,5 %
for the period from 2005 to 2009. This growth profile is influenced by the policy settings agreed by
the new coalition government. The reference scenario, considered against currently available infor-
mation, appears plausible, but may be slightly favourable in the outer years of the programme. The
programme's projections for inflation appear realistic.

The main goal of the medium-term budgetary strategy indicated in the programme is to ensure the
long-term sustainability of public finances. To achieve this, the programme proposes to continue
budgetary consolidation, while improving the conditions for growth and employment. The
programme envisages correcting the excessive deficit by 2007. Specifically, for 2006 and 2007 the
projections in the update are for nominal deficits of 3,3 % and 2,5 % of GDP, respectively. There-
after, the deficit is projected to decline by 0,5percentage point of GDP per year to reach a level of
1,5 % of GDP in 2009. The budgetary adjustment is both revenue- and expenditure-based. The
programme identifies the restraint in social expenditure as the crucial element of the consolidation
strategy. On the revenue side, an increase in the tax share is broadly offset by a decrease in the
share of social contributions. The share of public investment in GDP is projected to remain constant.
Compared with the previous update, the adjustment path has remained broadly the same. However,
the deficit ratio is planned to be higher for each year by a rounded 0,5 percentage point, and for
2006 by even more, than foreseen in the previous update.

The correction of the excessive deficit by 2007 entails, according to the programme, an improve-
ment in the structural balance (i.e. the cyclically-adjusted balance net of one-off and other temporary
measures) by more than one percentage point cumulatively between 2005 and 2007, concentrated
in 2007. Over the programme period, the structural balance calculated according to the commonly
agreed methodology is planned to improve on average by about 0,5 % of GDP per year, although
slightly less in 2008 and 2009. The programme sets the medium-term objective (MTO) for the
budgetary position as balance in structural terms, which, however, it does not aim to achieve within
the programme period. As it is more demanding than the minimum benchmark (estimated at a
deficit of around 1,75 % of GDP), its achievement should fulfil the aim of providing a safety margin
against the occurrence of an excessive deficit. The programme's MTO lies within the range indicated
for euro area and ERM II Member States in the Stability and Growth Pact and the code of conduct
and is slightly more demanding than implied by the debt ratio and average potential output growth
in the long term.

Concerning 2006, the risks to the budgetary outcome are considered to be balanced. However, as
from 2007, the budgetary outcome could be worse than projected in the programme. The restraint
in social spending, which is not laid out in full detail in the programme but is supposed to provide
a key contribution to the budgetary adjustment, hinges on the rigorous implementation of the
plans. Social expenditure has been one of the main drivers behind the overshooting of the budgetary
targets compared with previous programmes. The budgetary targets would be jeopardised if the
planned exoneration on social contributions was fully carried out without achieving the corre-
sponding expenditure targets. Moreover, shortfalls in growth might imply shortfalls in revenues,
which might prove difficult to compensate by further reduction in expenditure in order to maintain
the planned path of the deficit ratio. The programme further announces reforms of the corporate
tax system by 2008 and to health and long-term care insurance which, if not fully financed as envi-
saged in the programme, would entail a negative impact on the deficit in the short term.

In view of this risk assessment, the budgetary stance in the programme seems consistent with a
correction of the excessive deficit by 2007. However, it does not seem to provide a sufficient safety
margin against breaching the 3 % of GDP deficit threshold with normal macroeconomic fluctuations
until the penultimate year of the programme period. In the years following the correction of the
towards the programme's MTO implied by the
excessive deficit,

the adjustment

the pace of

(1) As in previous years, the update contains only rounded data and sometimes period averages for the outer years of
the programme period. It has gaps in the compulsory data and does not provide all optional data prescribed by the
new code of conduct (especially data on unemployment, sectoral balances and a breakdown of tax revenues are
missing).

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programme is broadly in line with the Stability and Growth Pact, which specifies that, for euro area
and ERM II Member States, the annual improvement in the structural balance should be 0,5 % of
GDP as a benchmark and that the adjustment should be higher in good economic times and could
be lower in bad economic times.

(11)

The debt ratio is estimated to have reached 67,5 % of GDP in 2005, above the 60 % of GDP refer-
ence value of the Treaty. The programme projects the debt ratio to increase to a rounded 69 % of
GDP in 2006 and to decline thereafter to reach 67 % at the end of the programme period. The
evolution of the debt ratio might be less favourable than projected in the programme, given the
risks to the budgetary targets mentioned above. In view of this risk assessment, the debt ratio may
not be sufficiently diminishing towards the reference value.

(12) With regard to the sustainability of public finances, Germany appears to be at medium risk on
grounds of the projected budgetary costs of ageing populations (1). The structural reforms carried
out in previous years, and in particular the pension reform, have helped to contain future rises in
public expenditure. In view of the current level of government gross debt exceeding the Treaty refer-
ence value of 60 % of GDP and the currently high structural deficit, implementing rigorously a
strong budgetary consolidation over the programme period is necessary so as to reduce the risks to
long-term sustainability.

(13)

The envisaged measures in the area of public finances are broadly consistent with the broad
economic policy guidelines included in the integrated guidelines for the period 2005-2008. In par-
ticular, Germany plans to implement a number of structural reforms in order to improve the
sustainability of government finances in the medium to long run. If the expenditure restraint in the
social security systems was implemented as planned, the composition of public expenditure would
be more favourable towards growth-enhancing categories in line with the Lisbon strategy.

(14) Germany's National Reform Programme (NRP), submitted on 7 December 2005 within the context
of the renewed Lisbon strategy for growth and jobs, identifies six key challenges: the knowledge
society; market functioning and competitiveness; business environment; the sustainability of public
finances (including sustainable growth and social security); ecological innovation; and the re-orienta-
tion of the labour market. Overall, the measures in the area of public finances envisaged in the stabi-
lity programme are in line with the actions foreseen in the National Reform Programme. The
budgetary implications of the actions outlined in the NRP are broadly reflected in the budgetary
projections of
the stability
programme envisages, as part of the reform of the federal system, that potential sanctions, which
might arise from the Stability and Growth Pact, would be allocated according to a rule across levels
of government. This would be inserted into the German Constitution.

In addition to the content of

the stability programme.

the NRP,

In view of the above assessment, the Council welcomes the priority attributed by the government to
budgetary consolidation as laid out in the programme, but notes that there are risks linked to the achieve-
ment of the budgetary targets and to long-term sustainability of public finances. Also in the light of the
Council decision of 14 March in accordance with Article 104(9) of the Treaty, the Council
invites
Germany to:

— Ensure the planned cumulative structural adjustment of at least one percentage point in the years 2006
and 2007 which would bring the general government deficit below 3 % of GDP at the latest by 2007
in a credible and sustainable manner;

— Rapidly achieve the medium-term budgetary objective through a reduction in the structural balance of
at least 0,5 percentage point per year after the excessive deficit has been corrected, notably by imple-
menting the planned expenditure restraint rigorously so as to be able to provide the planned relief on
social contributions, and by ensuring that the announced reform on corporate taxation does not jeopar-
dise the fiscal consolidation;

— Implement the plans to reform the federal system in order to improve the budgetary framework and

thus contribute to ensuring that budgetary targets are achieved at all levels of government.

(1) Details on long-term sustainability are provided in the technical assessment of the programme by the Commission

services
(http://europa.eu.int/comm/economy_finance/about/activities/sgp/main_en.htm).

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Comparison of key macroeconomic and budgetary projections

2004

2005

2006

2007

2008

2009

Real GDP
(% change)

HICP inflation
(%)

Output gap
(% of potential GDP)

General government
balance
(% of GDP)

Primary balance
(% of GDP)

Cyclically-adjusted
balance
(% of GDP)

Structural balance (2)
(% of GDP)

Government gross debt
(% of GDP)

SP Feb 2006

COM Nov 2005 (6)

SP Dec 2004

SP Feb 2006

COM Nov 2005

SP Dec 2004

SP Feb 2006 (1)

COM Nov 2005 (5)

SP Dec 2004 (1)

SP Feb 2006

COM Nov 2005

SP Dec 2004

SP Feb 2006

COM Nov 2005

SP Dec 2004

SP Feb 2006 (1)

COM Nov 2005

SP Dec 2004 (1)

SP Feb 2006 (3)

COM Nov 2005 (4)

SP Dec 2004

SP Feb 2006

COM Nov 2005 (7)

SP Dec 2004

1,6

1,6

1,8

—

1,8

—

– 0,6

– 0,6

– 1,2

– 3,7

– 3,7

– 3,75

– 0,8

– 0,8

– 0,5

– 3,4

– 3,3

– 3,0

– 3,4

– 3,3

—

65,5

66,4

65,5

0,9

0,8

1,7

—

2,0

—

– 0,9

– 0,9

– 0,9

– 3,3

– 3,9

– 2,9

– 0,5

– 0,9

0

– 2,9

– 3,2

– 2,4

– 3,0

– 3,2

—

67,5

68,6

66

1,5

1,2

1,75

—

1,6

—

– 0,7

– 0,8

– 0,7

– 3,3

– 3,7

– 2,5

– 0,5

– 0,9

0,5

– 2,9

– 3,2

– 1,9

– 2,9

– 3,2

—

69

70,0

66

1

1,6

2

—

1,1

—

– 1,1

– 0,4

– 0,3

– 2,5

– 3,3

– 2

0,5

– 0,4

1,5

– 1,8

– 3,0

– 1,6

– 1,8

– 3,0

—

68,5

71,4

65,5

1,75

1,75

—

—

—

—

—

—

—

—

—

—

– 0,7

– 0,4

—

– 0,0

– 2

—

– 1,5

1,25

—

2

—

—

– 1,5

—

—

1,5

—

—

– 1,5

– 1,1

—

– 1,3

– 1,5

—

—

– 1,1

—

—

68

—

65

—

—

67

—

—

Notes:
(1) Commission services calculations on the basis of the information in the programme.
(2) Cyclically-adjusted balance (as in the previous rows) excluding one-off and other temporary measures.
(3) One-off and other temporary measures taken from the programme (0.1% of GDP in 2005).
(4) One-off and other temporary measures taken from the Commission services' autumn 2005 forecast.
(5) Based on estimated potential growth of 1.1%, 1.1%, 1.1% and 1.2% respectively in the period 2004-2007.
(6) According to first estimates, growth was 0.9% in 2005. The Commission services' interim forecast of 21 February 2006 projects

growth at 1.5% in 2006.

(7) The ratio was calculated using the GDP series with the old method of accounting for FISIM (financial services indirectly measured), so

data are not directly comparable.

Source:
Stability programme (SP); Commission services' autumn 2005 economic forecasts (COM) on the basis of unchanged policies before the
new government took office in November 2005; Commission services' calculations.