Germany wants looser fiscal rules to meet Europe’s defense challenge

BRUSSELS ― Germany is pushing Brussels to reform freshly agreed fiscal rules to allow for greater defense spending, marking a dramatic policy shift driven by transatlantic developments.

The EU’s new fiscal rules entered into force just last year following highly-charged negotiations between countries backing tight budget discipline and those advocating for greater fiscal leverage.

On Tuesday, the European Commission proposed an emergency clause allowing countries to temporarily increase their defense spending by up to 1.5 percent of GDP a year over four years, but even this, the Germans now say, is not enough.

In a meeting of EU ambassadors on Wednesday, the German delegation argued that while the Commission’s move was a positive first step, it would not be enough to meet the new realities of Europe’s security position in the medium and long term, and that changes to the fiscal rules would be needed, three EU diplomats aware of the talks told POLITICO.

The diplomats, like others quoted in this story, were given anonymity to speak freely about the closed-door meetings.

The irony of the situation is striking: for years, Germany has been the most powerful fiscal hawk in Brussels, asking for strict budgetary discipline across the bloc.

When governments floated the possibility of an exemption for defense investments when the original fiscal rules were being negotiated, Germany’s former Finance Minister Christian Lindner was among the fiercest opponents of the idea, with countries such as Poland and Italy strongly supporting it.

But now, faced with mounting security concerns and shifting geopolitical realities, it is Berlin leading the charge for more flexibility.

The full force of the about-turn became evident on Tuesday when the center-right CDU and the center-left SPD — the two main parties that are set to lead Germany following last month’s election — struck a landmark deal to boost defense investments by reforming Germany’s controversial debt brake. The constitutionally-mandated restriction has stopped Europe’s biggest economy from using fiscal largesse to strengthen its internal demand for nearly fifteen years.

The German request “was unexpected: it got a lot of interest,” said one of the diplomats previously referenced.

“That was a funny exchange,” said a second diplomat. The French ambassador “had to warn Germany against too much flexibility in fiscal rules. Everyone laughed,” the person added.

The historic agreement between Friedrich Merz’s CDU and Olaf Scholz’s SPD creates an exception that allows for defense spending over 1 percent of GDP on a permanent basis.

The historic agreement between Friedrich Merz’s CDU and Olaf Scholz’s SPD creates an exception that allows for defense spending over 1 percent of GDP on a permanent basis. | Ralf Hirschberger/AFP via Getty Images

Advisors of the two parties calculated that €400-500 billion investments would be needed to strengthen the country’s defense capability over the next few years, a figure that makes the Commission’s plans look unambitious.

To compare, the EU’s current fiscal exception plan aims to unlock about €650 billion in additional spending across the entire bloc, according to the EU executive’s estimations.

Markets reacted rapidly to the German deal, with Berlin’s borrowing costs jumping over 10 percent in the day, the largest rise since 1997, in anticipation of an incoming debt deluge.

While governments with stretched budgets often experience bond-market sensitivity, Germany’s historical fiscal prudence has helped to establish the Bund market as one of the most stable in the world.

Those days, however, may soon be gone. “The geopolitical context has changed,” said the first diplomat referenced above, stressing that the need to increase defense spending will not go away soon.

Not that Germany’s concerns are isolated. Many EU countries feel they can no longer rely on the U.S. security umbrella with Trump at the helm of a new global order.

“It is like we have switched off the sun and now we need to pay every day for the heating,” a fourth diplomat said, discussing the new reality.

Leaders may discuss the request on Thursday when they gather in Brussels for a special meeting on defense and Ukraine.

Gregorio Sorgi contributed to this report.