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Germany should consider easing debt brake, says IMF

The sun sets behind the financial district early evening in Frankfurt

By Maria Martinez

BERLIN (Reuters) - Germany faces rising spending pressures and the government should consider easing the debt brake, the International Monetary Fund said on Tuesday, but finance ministry sources said such a move carried the risk of fuelling inflation.

Altering the rules of the debt brake, which limits public deficits to 0.35% of gross domestic product, would require a two-thirds majority in the upper and lower houses of parliament.

"Germany's debt brake is set at a relatively tight level, such that the annual limit on net borrowing could be eased by about 1 percentage point of GDP while still keeping the debt-to-GDP ratio on a downward trend," the IMF said in a report.

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This would allow more room for "much-needed" public investment, it said.

In November, a court ruling blew a 60 billion euros hole in public finances and threw the government's financing framework into turmoil.

Although reforming the debt brake would ease fiscal consolidation, reforms to reduce medium-term spending pressures and increase revenues were also needed, the IMF added.

The brake is fiercely defended by Finance Minister Christian Lindner. According to finance ministry sources, the IMF recommendation carries risks.

"Reforming the debt brake harbours the risk of once again fuelling inflation, which has only just started to fall," said the sources, adding that higher debt also meant higher interest rate costs.

In its World Economic Outlook published in April, the IMF cut its forecasts for German gross domestic product to 0.2% growth in 2024 and 1.3% in 2025, expecting a gradual consumption-led recovery this year as inflation continues to ease.

A return to growth is expected to gradually reinforce confidence, further bolstering consumption in 2025.

Private investment is also expected to recover in 2025 on the back of improved demand and moderate monetary policy during 2024 and 2025. "As a result, GDP growth is projected to accelerate to between 1.0% and 1.5% during 2025-26," the IMF said.

Over the medium term, rapid population aging is expected to slow growth and adversely affect public finances.

As baby boomers retire and recent immigration waves subside, the annual growth rate of Germany's working-age population is expected to fall by around 0.7 percentage points, more than any other G7 country.

These unfavourable demographics are projected to slow annual growth to around 0.7% over the medium term.

The IMF said medium-term growth prospects could be bolstered by increasing public investment, including in the green transition and digitalisation.

To further boost productivity and entrepreneurship, the government should deepen efforts to cut red tape and promote digitalisation, the IMF advised.

(Reporting by Maria Martinez; Editing by Nick Macfie)