© Reuters. German Finance Minister Christian Lindner is pictured next to the recording light of a TV camera as he presents Germany’s new tax revenue estimates in Berlin, Germany, October 26, 2023. REUTERS/Liesa Johannssen/File Photo

By Maria Martinez and Christian Kraemer

BERLIN (Reuters) -The German government froze major spending pledges focused on green initiatives and industry support on Wednesday after a constitutional court ruling on unused pandemic emergency funds blew a 60 billion euro ($65 billion) hole in its finances.

The decision threw into disarray budget negotiations taking place this week within Chancellor Olaf Scholz’s three-way ruling coalition, whose popularity has slumped as Europe’s biggest economy teeters close to another recession.

Wednesday’s decision by the constitutional court could also set a precedent for fiscal responses to future crises.

Finance Minister Christian Lindner will meanwhile face increased scrutiny over how he plans to keep spending in check, just days before he is due to meet his French counterpart for talks on enforcing fiscal discipline across the European Union.

Germany has hitherto burnished its reputation as the defender of sustainable financing in negotiations to reform EU fiscal rules in a pan-European deal by the end of the year.

Scholz said the ruling on Wednesday would have far-reaching consequences for the government’s Climate and Transformation Fund (KTF) but that his coalition would look for other sources of funding.

“We will now quickly revise the economic plan, incorporate the necessary changes and adopt new ones,” he said on social media.

Lindner said the ruling could have a big impact on federal and state budgets but the government would respect the decision and not interrupt the process of finalising the budget for 2024.

The 60 billion euros had been earmarked for initiatives such as making buildings more energy efficient and subsidising renewable electricity and chips production, as well as supporting energy-intensive companies.

Lindner said moves to promote energy efficiency and renewable energy use in the building sector would be excluded from the freeze.

But he may face growing calls from within the coalition to suspend Germany’s constitutionally enshrined debt brake again, something he has hitherto ruled out, along with raising taxes.

“This ruling will come as a massive setback to the government. The practice that was now dismissed by the court had allowed the government to forge policy compromises that kept all three parties in Scholz’s coalition satisfied,” said a note by the Eurasia group.

“Spending cuts now look unavoidable and Eurasia Group believes that the bulk of the cuts will likely hit climate-related projects.”

“FAR-REACHING CONSEQUENCES”

Scholz’s centre-left Social Democrats (SPD), Economy Minister Robert Habeck’s pro-spending Greens and Lindner’s fiscally cautious Free Democrats (FDP) agreed in December 2021 to transfer debt raised to help the country cope with COVID-19 to a climate fund. The move – via the Second Supplementary Budget Act 2021, which retroactively amended the 2021 Budget Act 2021 – allowed the parties to make the most of a temporary suspension of borrowing limits in the constitution.

The constitutional court ruled that the Second Supplementary Budget Act was incompatible with the debt brake enshrined in Germany’s constitutional Basic Law and so was void. The debt brake restricts the German public deficit to 0.35% of GDP.

“The court ruling has far-reaching consequences for fiscal policy in Germany,” said Clemens Fuest, President of the Ifo economic institute.

“There are significant constraints for federal budgets in coming years in terms of spending on government support for decarbonisation.”

Germany’s 2024 budget and financial plans through 2027 are due to be finalised on Friday, as Germany curbs spending that surged in response to COVID-19 and the Ukraine war.

“In the logic of Germany’s constitutional debt brake, today’s ruling makes sense,” said a note by ING.

“However, the question remains whether the debt brake makes economic sense when the country struggles with structural stagnation and a long list of serious challenges and transitions, of which many need fiscal support.”

Habeck had previously warned that a negative ruling would “sweep the rug from underneath” the government’s plans to stabilise the economy.

Friedrich Merz, whose main opposition Christian Democratic Union party had launched the lawsuit against the government, said the ruling had stopped what he called “the self-service mentality” of the government and strengthened the debt brake.

“A key cornerstone of the government’s budget and financial planning is collapsing,” he told local media.