BERLIN, March 14 (Reuters) – German
chancellor-in-waiting Friedrich Merz reached an agreement with
the Greens on Friday on a massive increase in state borrowing,
just days before a parliamentary vote on the issue, a source
close to the negotiations said.

The agreement by the parties hoping to form its next
government includes a 500 billion euro ($545 billion) special
fund for infrastructure and plans to unshackle defence
investment from the country’s debt rules.

Here is what the plans might mean for growth and debt in
Europe’s largest economy:

COULD THE SPENDING BOOST GERMANY’S AILING ECONOMY?

According to economists, yes.

Germany’s planned infrastructure fund alone could raise
economic output by an average of more than two percentage points
per year over the next 10 years, Germany’s DIW economic
institute said on Friday.

With the deal on a defence and infrastructure spending
ramp-up, growth of 2.1% is expected in 2026, instead of 1.1%,
DIW said.

Another institute, the IfW, has also revised up its 2026
growth estimate for Germany, predicting expansion of 1.5% on the
back of the expected boom in public spending.

The IMK economic institute, which has yet to update its
forecasts, projects the German economy will eke out barely 0.1%
of growth this year, after two consecutive years of contraction
in 2023 and 2024, but said the new proposals could make a big
difference.

“If the financial package is implemented quickly, a
significant acceleration in growth can already be expected in
the second half of the year, and growth for the year as a whole
could already move noticeably away from stagnation,” said IMK’s
economic director Sebastian Dullien.

WHICH SECTORS ARE SET TO PROFIT MOST?

The construction sector can look forward to a boost from the
fund to overhaul Germany’s creaking infrastructure.

Shares in Heidelberg Materials rose by some 4% on
Friday. Bilfinger saw a 4.8% increase and Hochtief
shares were up 5%.

The defence industry also stands to gain. Under the
prospective coalition’s plans, Germany’s strict cap on borrowing
known as the ‘debt brake’ would be amended in the constitution,
having no upper limit on larger defence spending plans.

German defence companies Rheinmetall, Hensoldt
, Thyssenkrupp and Renk have
notched up gains so far on Friday of between 4.5% and 7.5% on
the news of the agreement.

HOW MUCH MORE DEBT WILL GERMANY TAKE ON?

A lot.

Last year, Germany’s debt ratio stood at around 64% of gross
domestic product, far lower than that of other major
industrialised countries such as the United States and France.

Commerzbank chief economist Joerg Kraemer expects that level
to climb noticeably in the coming years – by around 10
percentage points – due to the new special fund for
infrastructure alone.

Increasing defence spending would push up the debt ratio
even further, by an extra 2.5 points annually if, for example,
it was ramped up to 3.5% of gross domestic product.

“In 10 years, the overall government debt ratio could rise
to 90%, although this also depends on inflation and is therefore
not easy to predict,” Kraemer said.

“This would mean that Germany would quickly join the ranks
of the EU’s highly indebted states,” ZEW economist Friedrich
Heinemann said. He predicts Germany’s indebtedness could even
surpass the 100% mark in 2034.

WOULD THIS COST GERMANY ITS TRIPLE-A CREDIT RATING?

Not necessarily. The spending plans could increase Germany’s
debt level to around 72% of gross domestic product by 2029,
Scope analyst Eiko Sievert told Reuters – below the previous
high of 80% seen in 2010 following the global financial crisis,
when Germany was able to maintain its AAA rating.

“Whether this remains possible in the coming years depends
also on the implementation of necessary political reforms to
strengthen competitiveness and economic growth,” Sievert said.

CAN GERMANY FIND ENOUGH LENDERS?

Germany’s top credit rating makes it a sought-after
borrower. However, higher interest rates would probably be
needed to make German government bonds attractive to investors.

“Investors are likely to demand higher risk premiums for
German government debt,” says Commerzbank’s Kraemer.

The yield on the 10-year German government bond rose 7 basis
points to 2.93% as investors digested news of the agreement on
spending plans, indicating Germany’s debt interest payments
would likely rise.

COULD GERMANY’S SPENDING SPREE INFLUENCE ECB POLICY?

This could well be the case because pumping hundreds of
billions of euros into the economy harbours inflation risks.

“The ECB will have to take into account that inflationary
pressure will rise again as a result of the planned expansionary
fiscal policy in Germany,” said Cyrus de la Rubia, chief
economist at Hamburg Commercial Bank.
(Reporting by Rene Wagner, Maria Martinez and Chris Steitz,
Writing by Rachel More
Editing by Gareth Jones and Christina Fincher)