United EU Fiscal Response to Energy Crisis Remains Challenging

The German government set out a debt-financed package at the end of September of up to 200 billion euros ($196.35 billion), or 5.5% of GDP, to support households and businesses. The announcement raised concerns at the European Commission and in other European countries, which support a coordinated response to the energy crisis prompted by Russia’s cutback in supplies.

“We need to reflect urgently on how to offer member states -which don’t have this fiscal room for maneuver-the possibility of supporting their industries and businesses,” EU Commissioner Thierry Breton tweeted in response to the German government’s announcement.

With rising interest rates, fiscal space in the periphery for more support is tightening, Citi’s economists said in a note. The German package risks undermining European solidarity, according to some European leaders. European officials argued that Germany’s use of its fiscal muscle to protect domestic industry threatened to distort and disrupt the EU’s single market by giving the country’s industry an unfair advantage over competitors.

While Germany has rejected calls for a common fiscal response to the energy crisis, the announcement of its borrowing package will make it more difficult for the government to continue ignoring the demands for more burden sharing in coming months, Eurasia Group’s managing director for Europe, Mujtaba Rahman, said in a note.

As cost-of-living pressure intensifies, German policies at odds with European interests will be heavily criticized, increasing the pressure on the government to support common borrowing next year, Mr. Rahman said.

“Chancellor Olaf Scholz has taken a significant reputational and political hit in the EU, but sustained pressure from Brussels and other EU capitals will likely create more space for possibly more EU common borrowing,” he said.

Commerzbank’s chief economist Joerg Kraemer doesn’t consider debt mutualization to be a good way forward for Europe, because it could encourage countries to overspend. “If a national government spends money at home but is not directly liable for the debt, then this creates incentives to spend too much, which in the end weakens the private sector,” Mr. Kraemer said.

According to Germany, there is still enough money available in the NextGenerationEU stimulus program that could be used to respond to the energy crisis, Berenberg economist Holger Schmieding said. “But there is a chance that, for instance in future plans to rebuild Ukraine, Germany may later on agree again to new EU special funds that are underwritten by all member states,” he added.

Although Germany might make some concessions as EU responses to the current crisis advance, EU common debt borrowing seems unlikely this time.

“As during the pandemic, a pan-European fiscal stimulus answer would help avoiding a new euro crisis or market turmoil as recently in the U.K.,” ING’s global head of macro Carsten Brzeski said. However, this time the German economy has been hit much harder than other economies, unlike during the pandemic, he said.

For Mr. Brzeski, the question is whether chances for common debt are higher with an economically strong or weak German economy.

“I fear that common debt issuances with a weak German economy are less likely,” he said.