The turnaround in interest rates is here. On Thursday, the ECB significantly increased its key interest rate to 0.5 percent after eleven years. The long phase of low interest rates is now coming to an end. For Federal Finance Minister Christian Lindner (FDP), higher interest rates are one of his biggest challenges. Even before the ECB’s decision, he pointed out that the federal government’s interest payments would increase significantly again.
In other words, there is less scope for other expenses. Expenditure on interest in 2023 will amount to almost 32 billion euros, according to Lindner’s planning. A good 18 billion should be enough this year. For 2021 there is a net total of almost four billion euros in the budget.
If you look at the draft budget for 2023 approved by the cabinet two weeks ago, you might rub your eyes in amazement. Interest expenditure on federal bonds will fall slightly to 12.2 billion euros. Bunds make up the majority of federal interest-bearing securities. The interest costs of other common financial instruments disappear behind it.
But how does Lindner come up with more than 30 billion euros in interest expenses in total? You will find what you are looking for a few lines down in section 32 of the draft budget. There is talk of interest in connection with a final payment financing law (7.6 billion euros) and of “disagio” on bonds and bonds (8.5 billion). With other smaller interest posts, the total amount is almost 32 billion.
What happens there? The answer, to put it bluntly: You are dealing with a mixture of creative budget management and the consequences of decisions that go back to the tenure of Finance Minister Peer Steinbrück – but which Lindner now knows how to use. His goal is obviously to present the turnaround in interest rates as a major burden on the one hand, and on the other hand to contain the consequences for budget planning as far as possible. Therefore, a bit of trickery and deception is the order of the day in the Federal Ministry of Finance.
Last but not least, this applies to the item called “Disagio”. The term hides price reductions that arise when the federal finance agency cannot – or should not – achieve the full price at the auction of bonds. The nominal value of federal bonds is usually 100 euros per piece. The opposite – the surcharge – is called “agio”, and the finance ministers before Lindner did good business with it for years.
In order to understand the procedure, you have to delve a little into the complex world of the bond business. This includes the government taking out new loans not just by issuing new bonds, but also by topping up bonds that have been in circulation for more or less a long time. In the phase of very low interest rates, the federal government repeatedly offered to top up old bonds with a relatively high interest coupon. This allowed buyers to purchase securities with relatively high interest rates for years to come, and in return they accepted a purchase price that was higher than face value. The return was still right.
Former finance ministers Wolfgang Schäuble and Olaf Scholz collected this surcharge immediately and entered the total amount in the respective annual budget. In 2020, twelve billion euros came together, in 2021 it was a good ten billion. That was good extra income, which also made it easier to comply with the debt brake. From an accounting point of view, it would also have been possible to distribute this income over the remaining term of the increased bonds, just as the interest burden from these increases is distributed to later budgets. But that was not done. The quick win was more important.
In the meantime, however, price reductions are predominant due to the turnaround in interest rates. It is obviously the line of Lindner and his responsible state secretary Werner Gatzer to extend the phase of cheap debt for the federal government by topping up bonds with low or zero interest rates. The fact that the federal finance agency, formally an independent GmbH, has been doing this extensively for a long time in order to keep federal bonds liquid and thus to support their “benchmark status” – the pole position in the bond business, so to speak – suits this policy.
A current example: On July 13, a zero-interest bond issued for the first time in 2021, which has a term of 30 years, was increased. The financial institutes involved in the auction bought it, albeit at a significant price discount – the average price was just under 66 euros (at a nominal value of 100). Lindner therefore waives income. It’s a question of weighing up: the federal government takes in less, but pays no interest for years to come. In principle, however, the discount solution is not considered to be more advantageous than a new issue with higher interest. The turnaround can already be seen in the draft budget for 2022: only around 670 million in premium income is posted there.
In 2023, this development will then take hold on a massive scale. The draft budget now includes the aforementioned 8.5 billion euro discount. The extension of zero-interest bonds via taps partly explains why the actual interest payments for federal bonds in the budget plan do not increase, but fall slightly to the planned EUR 12.2 billion. In addition, older bonds from times when interest rates were high are being replaced by bonds with lower interest coupons – which in turn significantly reduces premium business. When issuing new bonds, the federal government has to offer a significantly higher interest rate – most recently on July 6 it was 1.7 percent for a ten-year bond.
The price reductions from the discount campaigns are included in the budget as expenses. With these higher costs, the finance minister can suppress spending requests from other departments. In fact, the disagio is a shortfall in revenue. Like the premium, the discount is also booked in one fell swoop. Lindner wouldn’t have to do that, but because the one-time posting is the ministry’s conventional practice, it will continue with the haircuts.
The Düsseldorf financial analyst Peter Barkow saw the trend reversal from premium to discount coming. “Now the boomerang is here,” he told the Tagesspiegel. “The federal government was caught on the wrong foot, but it’s in good company.” According to his calculations, by mid-June there had already been a reduction in revenue of 2.7 billion euros – significantly more than what Lindner had planned Total of 670 million.
There has long been criticism of the Finance Ministry’s posting practice for premiums and discounts – not least from the Bundesbank, the Scientific Advisory Board of the Finance Ministry and the Federal Audit Office. The concerns already applied to Schäuble and Scholz, who did not react to them – as does Lindner now. In June 2021, the Bundesbank last criticized the booking of all premium income in one fell swoop. This would “temporarily loosen the limits of the debt brake at the expense of future budgets”. According to the Bundesbank, the “changeover to an accrual-based distribution of interest expenditure” would be “more economically appropriate”. One conclusion was: “The actual budget situation would then be easier to identify.” The Court of Auditors’ criticism dates back to 2017.
The Scientific Advisory Board of the Ministry of Finance, a group of 35 professors including Lindner’s close advisor Lars Feld, saw it in a similar way in April 2021. In a 30-page paper on the subject of “Federal debt management”, the immediate posting of premiums and discounts is sharply criticized – also with a view to the fact that there could be a turnaround in interest rates.
Higher discounts are “not additional expenses,” the paper says. “They merely represent a time shift of future interest payments into the current budget.”
The Advisory Board clearly warned of the “accounting burdens” should interest rates rise. The recommendation: distribute the price reductions over a longer period of time. This would give more planning certainty because the effective interest burden would be better reported in the budget, according to the tenor of the paper.
But what about the other item and the EUR 7.6 billion in interest expenses listed there? Behind the final payment financing law from 2009 (Steinbrück’s last year in office) is a special fund, i.e. a secondary budget in which a reserve is accumulated. Namely for the repayment of federal bonds, which are linked to inflation. These bonds pay very low annual interest rates, but each year additional inflation-linked interest is offered, which is only paid out cumulatively at the end of the bond’s term. The government’s inflation bonds have maturities of between ten and 30 years.
In order to equalize this “cluster risk” of high one-off payments, the saving of the reserve was introduced – although at the time nobody thought that this would create a new cluster risk should there be years with very high inflation again. There are now, which is why Lindner has to put very high sums into the reserve in 2022 and 2023. However, this is only indirectly related to the turnaround in interest rates. The total of 12.2 billion euros in this and the coming year is a legal obligation that Lindner inherited from his predecessor Peer Steinbrück and which now – depending on how inflation develops – is a significant burden on the federal budget.
Inflation-linked bonds make up only a small proportion of the federal securities in circulation. According to the finance agency, there are currently only five bonds, the share of the total volume is a little less than five percent. But their share of interest expenses in 2023 is more than a quarter.