The federal government plans to spend 30 billion euros on interest on government bonds in 2023. Last year it was only 4 billion euros. The difference cannot be explained by the rise in interest rates, but it can be explained by a balance sheet trick that is now working against Germany.
Federal Finance Minister Christian Lindner (FDP) is good at interpreting figures in a way that serves his own political agenda. “It cannot be ruled out that we will pay up to 30 billion euros in interest next year,” he said in an interview with Welt am Sonntag in mid-June. The number is surprising, since the interest costs last year were only around 4 billion euros. Even if the European Central Bank (ECB) is likely to raise interest rates again for the first time in years on July 21 and will continue to do so in the coming quarters, the rates will not shoot up so much that Germany’s interest burden would have to increase more than sevenfold.
However, Lindner does not even go into the details of this calculation. He links the rapidly rising interest burden directly to demands for where Germany could save. For example, he wants to eliminate purchase premiums for electric and hybrid cars and cut support for the long-term unemployed. “We can save many billions that we could use more sensibly,” says the minister.
But a look at the details is important in order to understand in this case that Germany’s interest costs are only growing so strongly on paper and that it is actually not even the interest rates themselves that will cause such high expenses in the coming year. Rather, it is a balance sheet trick that is responsible, which Germany used to its advantage during the low phase and which is now being reversed when interest rates are rising.
It works like this: Between 2014 and 2019, the federal government did not take on any new net debt. The notorious “Black Zero” stood ironclad until the Corona crisis. This does not mean, however, that the federal government has not taken on any new debt. After all, government bonds are constantly running out, which the federal government then has to pay for. To do this, he takes on new debts. Taken together, this does not increase the debt burden.
The replacement of old debt with new debt can be done in two ways. One would be to pay the creditor the old government bond after it expires and issue a new government bond. This is a method that the finance agency responsible for federal bonds in Frankfurt am Main uses constantly. In the past year alone, 480 billion euros were newly borrowed, with only half of this being new net debt.
Another way to refinance old debt is to add to long-dated government bonds from previous years. This has two advantages: First, these bonds, which have a term of more than 30 years, for example, already have an excellent AAA rating from the leading rating agencies. So they are a very safe investment for buyers. Second, they have a higher interest rate than new bonds. If the old long-dated bond was issued around 2005, it might have had a coupon of 2.5 percent per year. That’s a lot more attractive than the 0.0 percent that was up until this year.
Obviously, however, it is not worthwhile for the federal government to simply top up an old bond. After all, he would have to pay higher interest for it than with a new issue. Therefore, investors pay a higher price for a bond with higher interest rates. The difference between the nominal value of a bond – that is the amount that the federal government has to repay after maturity – and the higher purchase price is called the premium. It serves to compensate for the higher interest charges.
The premium would therefore be offset on the issuer’s balance sheet over the remaining term of the bond, offsetting the higher interest rates each year. But the union doesn’t do that. He immediately offsets the entire premium against the interest payments for the same year. On paper, interest costs fell significantly between 2012 and 2021. The management consultancy Barkow Consulting from Düsseldorf estimates the income from agios in this period at 45 billion euros. In 2020, the income peaked at 12 billion euros, for 2021 the Federal Ministry of Finance put it at 10.9 billion euros.
But when interest rates rise, this effect reverses. Instead of paying higher interest for a new issue now, the federal government is also topping up long-term bonds with interest rates of 0.0 percent from the years 2012 to 2021. While investors previously had to pay him a surcharge called agio for the higher interest rates, he now has to compensate investors for the lower interest rates with a discount, the discount.
In the long run, it may be cheaper to pay this discount to secure low interest rates on existing bonds than to issue new higher-yielding bonds. Actually, a discount would also be charged over the remaining term of a bond, but because the federal government charged the premiums directly in the year of issue, it has to do the same for the discounts.
This suddenly results in high costs on paper. Barkow Consulting estimates that Germany will have to pay 4.7 billion euros for this this year alone. Compared to the premium plus of 10.9 billion euros from the previous year, this results in higher interest payments of 15.6 billion euros. A single 30-year “green” bond tops the hit list with discount costs of 1.3 billion euros.
“Ultimately, one could have avoided the whole dilemma by delimiting the one-time income, as would have been economically correct according to international accounting standards,” says company boss Peter Barkow. However, the black zero between 2014 and 2021 would not have been possible. But just as this was based on beautifully calculated income, Lindner’s warnings about high interest payments in 2023 are now based on poorly calculated income. In reality, the high discount payments are balanced out in the long term by lower interest payments.
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