By Rene Wagner and Maria Martinez

BERLIN (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)

---