German Länder: Outlook for 2025 - Fiscal Performance Softening Amid Weak German Economic Momentum

German states ("Länder") are facing strong expenditure pressures as the impact of high inflation unfolds. At the same time, past strong tax revenue growth has flattened as inflation has cooled and economic momentum remained weak. German real GDP is set to have stagnated this year, and we anticipate only a moderate acceleration of economic growth next year. Still, we take the view that the fiscal performance of Länder remains solid in international comparison amid the increased fiscal challenges. We foresee that the Länder sector should post moderate financing deficits of around 2% of operating revenues in 2024 and 2025. Tight debt brake rules limit more pronounced deficits in many of the states. The sector's debt burden remains at elevated levels at around 115% of operating revenue in 2024. We anticipate that Länder will intensify debt-financed infrastructure investments over the next years, which will likely elevate the sector's bond issuances over the medium-term.

Key Highlights
-- Fiscal performance of German Länder has softened in 2024 as inflation impact unfolded and tax revenue slowed.
-- We anticipate only a moderate uptick of German economic momentum in 2025, which limits the prospects for sector improvement.
-- Higher fragmentation has arrived in Länder parliaments and poses greater challenges to policymaking.

"Expenditure pressures are testing the Debt Brake Rules in many Länder, as prospects for revenue growth remain limited," said Marius Schulte, Assistant Vice President in the Global Sovereign Ratings Group. "While the sector's fiscal position remains solid by international comparison, we foresee persisting challenges from subdued tax revenue growth and high investment needs, amid increasing political fragmentation."