The Covid-19 pandemic weakened German states’ fiscal performance in 2020 and revenues may not return to pre-pandemic levels until 2022, Fitch Ratings says.
Weaker fiscal performance could weigh on some Laender Standalone Credit Profiles, but would not directly affect their ratings, which are equalised with those of the German sovereign.
The 16 Laender reported an overall deficit of almost EUR42 billion in 2020, following a surplus of more than EUR13 billion in 2019, according to preliminary data from the Federal Finance Ministry. Total tax revenue declined by 4.9% to EUR294.4 billion, although aggregate operating revenue increased by 4.5% to EUR417.8 billion. Current expenditure rose by EUR65.4 billion.
Operating revenues were supported by sharply higher transfers from the federal government (Bund), which increased by EUR35 billion (or 52%). However, these pass-through allocations, provided to help fund Laender operating expenditure (opex), did not fully offset the costs of the pandemic, as opex rose by nearly 20% yoy to EUR414.5 billion in 2020. The larger increase in opex meant that the Laender reported an operating deficit at end-2020, compared with an operating surplus of 13.1% in 2019.
The overall deficit is increasing collective Laender debt. The most recent data available show that this grew by 7.7% in the year to end-3Q20 to almost EUR569 billion.
Bund and Laender have agreed that the cost of tackling the Covid-19 pandemic justifies suspending the debt brake agreement, which would have prohibited any Land running a structural budget deficit from 2020 and which is now unlikely to apply before 2022.
Additional funding requirements have not affected Laender’s debt market access or borrowing costs, reflecting their status as Europe’s largest subnational borrowing group enjoying frequent and reliable market access.
Fitch affirmed the ‘AAA’/Stable ratings of 11 Laender in April 2020. Our updated rating case assumed that the pandemic would cause material changes in revenue and cost profiles across the sector, and projected that these would worsen as long as government restrictions on economic activity were maintained or broadened.
The second wave of Covid-19 infections and re-imposition of some lockdown measures has not had as large an economic impact as in 1H20 and the Bund will continue to make transfers available.
Nevertheless, Laender may take on additional debt to facilitate spending until economic activity and tax revenues start to normalise. We expect aggregate debt to rise again this year, although the increase will be smaller as Laender budgetary performance improves relative to 2020.
Rising debt weakens Laender’s Economic Liability Burdens (ELBs). A measure of sub-sovereign debt-to-GDP that incorporates for the role of regional economic activity in servicing central government debt, the ELB is one of the core measures of debt sustainability in Fitch’s International Local and Regional Governments Ratings Criteria.
However, most Laender still have sufficient headroom for their ELBs to weaken without affecting their standalone credit profiles. At our April 2020 review, our rating-case assumptions only resulted in a change to one Laender’s ‘debt sustainability’ assessment (Saarland was lowered to the ‘bbb’ category from the ‘a’ category).
Laender Issuer Default Ratings (IDRs) are driven by the strong institutional framework under which they benefit from a constitutional ‘solidarity system’. IDRs are consequently equalised with those of Germany. We affirmed Germany’s ‘AAA’/Stable sovereign rating on 6 November 2020.
