By Maria Martinez

BERLIN (Reuters) -The German cabinet passed its 2025 budget on Wednesday after months of wrangling, even though a 17 billion euro ($18.6 billion) gap between projected spending and revenue has still to be covered.

German Finance Minister Christian Lindner told a news conference that the government was looking at innovative ways to reduce the gap.

The options under scrutiny are using extra funds from the state bank KfW and converting the grants of Germany’s national rail operator Deutsche Bahn and the highway company into loans.

Lindner said the constitutionality of these options is being studied, as the government is trying to avoid the chaos in November of last year, when a court ruling blew a 60 billion euros hole in public finances and threw the government’s financing framework into turmoil.

The cabinet also passed an economic package that aims to rev up the euro zone’s biggest economy and boost growth by more than half a percentage point in 2025. Stronger economic growth thanks to the economic package should generate additional revenues of 6 billion euros next year, according to the estimates of the economy ministry.

“With the growth initiative, we have put together a good package that improves the framework conditions for the economy,” German Economy Minister Robert Habeck said on Wednesday, noting a cut in red tape, work incentives to combat labour shortages and investment incentives.

New room for manoeuvre in the budget can only be created through more economic growth, Lindner said.

Some analysts suggested Lindner was stretching budget rules but he insisted it was a common state practice to have budgets with gaps “in the double-digit billion euro range” and German public finances were being kept on a sound footing.

Germany’s budget for 2025 includes a record 78 billion euros of investments, net borrowing of 43.8 billion euros and a total budget size of 481 billion euros, respecting a constitutionally-enshrined cap on spending, known as the debt brake.

“We are complying with the debt brake, which makes us an anchor of stability in Europe,” Lindner said.

Germany was the worst performing major economy last year, with gross domestic product contracting by 0.3%. It pulled out of recession early this year but growth has been slower than expected. “We are being left behind,” Lindner said.

Reaching agreement on the budget has been a major test for a coalition often accused of being hobbled by internal disagreements.

In June’s European election, the ruling parties in Germany’s coalition government fared poorly, with the far-right Alternative for Germany coming second behind the conservatives.

LONGER-TERM PLANNING

The budget for 2025 comes with mid-term financial planning until 2028, the year the armed forces special fund to meet NATO’s minimum spending goals is due to run out.

Days after Russia’s 2022 invasion of Ukraine, Chancellor Olaf Scholz announced a “Zeitenwende” – German for a historic turning point – with a 100 billion euro special fund to modernise the military.

In 2028, there is a gap of 39 billion euros in the regular budget, with 28 billion euros needed to comply with NATO spending targets without the special fund, finance ministry sources said.

Lindner noted the funding hole for 2028 was particularly big.

Next year’s budget will be less generous to Ukraine, with the government cutting military aid for the country to 4 billion euros from around 8 billion euros in 2024, according to a draft seen by Reuters.

Germany expects Ukraine will be able to fund the bulk of its military needs with $50 billion in loans from the Group of Seven backed by proceeds of frozen Russian assets. It hopes, therefore, that funds earmarked for Ukraine will not be fully used.

“Ukraine’s financing is secured for the foreseeable future thanks to the European instruments and the new G7 loans,” Lindner said.

Drafting both the 2025 budget and a medium-term financial roadmap through to 2028 was hard because Lindner demanded a period of fiscal consolidation after higher spending during the COVID-19 pandemic and the more recent energy crisis.

In addition, new European Union rules further restrict Germany’s fiscal headroom, requiring stricter adjustments than under national regulations, according to the finance ministry.

“This (budget gap) is perfectly legal, even though the draft leaves 3.3% of the budget unresolved that way, a record high and a sure sign that the creative bookkeeping needed to produce a legally sound budget was stretched to the limit this time,” Eurasia Group’s director for Europe Jan Techau said.

The drafts for the 2025 federal budget and a supplementary budget for 2024 will be discussed in the lower house of parliament from the second week of September.

“The second, more decisive and more controversial phase, will see heated public debates and lots of backroom deals,” Techau added, referring to negotiations likely to happen after the summer break.

The supplementary budget for 2024 is due to be passed in the lower house of parliament on Nov. 8 and the budget for next year on Nov. 29, with changes expected until those dates.

(Reporting by Maria Martinez, Holger Hansen and Christian Kraemer; Editing by Christina Fincher, Alexandra Hudson)

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