Municipalities and Infrastructure
KfW Research Position paper
Russia’s war of aggression against Ukraine and the COVID-19 pandemic have shaken the foundations of a rules-based world order and the German economic model. Even amid the necessary short-term crisis management, investments are key to successful adaptation to the changed environment. They make restructuring energy supplies and the green and digital transformation possible – and demand a joint effort by government, the business community and private households. The lion’s share of necessary investment will have to come from the private sector. The current burdens from high energy costs and uncertainties act as additional roadblocks. So it is all the more important to encourage and provide intelligent support for private investment. Government therefore has a key role to play: first, by formulating targets and setting frameworks and incentives and second, by investing in infrastructure and human capital, both of which are required for the productive realisation of private-sector activity.
Focus on Economics
The public sector will need to invest nearly EUR 500 billion in order for Germany to become climate neutral by 2045 – or around EUR 20 billion in climate investment each year. The highest amounts to be invested by the public sector will be in energy (EUR 297 billion), transport (EUR 137 billion) and buildings (EUR 47 billion). These amounts can definitely be funded from the public budgets, but even so, they represent a sixfold increase on the current investment level. Unless the responsibilities, financial flows and competences between the federal, state and local government levels are systematically realigned, it will hardly be possible to launch a sustained increase in necessary climate action investments.
While the KfW Municipal Panel 2022 retraces the effects of the coronavirus crisis and the flood disasters of 2021, the next challenges for municipalities from the impact of the Ukraine war are already foreseeable. Growing investment needs have increased the investment backlog amid significantly higher construction prices. At the same time, the budget position of many municipalities has not seen a durable recovery despite an improved overall situation. It is again becoming clear that municipal finances are not resilient enough for municipalities, communities and rural districts to meet the challenges they face without major disruptions even in times of crisis.
Focus on Economics
Transitioning municipal public infrastructure to climate neutrality requires high investment amounts which can hardly be funded from current budgets. The international capital market provides sustainable finance but municipalities have so far hardly tapped into this funding source because the customary capital market instruments are not suitable for many municipalities. Alternatives that are based on established instruments such as municipal loans are therefore necessary. However, in order to enable green municipal loans to achieve a breakthrough, further changes and pioneers will also be required in municipal finance.
Surprisingly, the financial support provided by the federal and state governments enabled municipalities to close the survey year 2020 with a small surplus. The great uncertainty about further financial developments, however, has the potential to adversely affect public investment as well as non-mandatory public services, such as sport and culture. The current KfW Municipal Panel 2021 therefore illustrates the need to take short- and medium-term measures that stabilise municipalities’ capacity to act so that they can sustainably address the major societal challenges and tackle the perceived investment backlog, which has now reached EUR 149 billion.
Although the German federal and state governments introduced a range of measures in 2020 to ease the strain on municipal budgets, considerable uncertainty remains, especially beyond 2021. This is also reflected in the responses returned by the municipalities surveyed for the KfW Municipal Panel 2021. The findings of a preliminary analysis highlight the risk of considerable cuts in municipal investment expenditure and discretionary activities. The uncertainty for public finances thus threatens to unleash long-term negative consequences beyond the crisis period unless financial planning certainty can be created for municipalities.
Municipalities are now much less optimistic about their finances as a result of the coronavirus crisis. Declining revenues and rising expenditures mean that the budget surpluses of the past years are likely to remain out of reach for the time being. Treasuries anticipate austerity measures to cover the budget deficits. This threatens to adversely impact capital expenditure in particular. Investment levels were already inadequate in 2019, as the perceived investment backlog has grown to EUR 147 billion, according to a national estimate. That does not bode well for local infrastructure and, hence, Germany’s competitiveness and quality of life.
Municipalities will have no shortage of investment needs and face more than enough challenges in meeting them in future as well. The message of the economic recovery package adopted on 3 June is therefore all the more important, as it should provide municipalities with a significant boost, not least for their capital expenditure.
The KfW Municipal Panel is based on an annual representative survey conducted by the German Institute for Urban Affairs. The survey covers municipal treasuries in cities, communities and districts and is recognised as an important point of reference in economic policy debate in Germany.
Focus on Economics
Demographic changes are driving the need for accessible housing. Today, Germany has some 3 million households with mobility restrictions and that number will grow to 3.7 million in 2035. However, only 560,000 homes are accessible. In order to reduce the enormous deficit, KfW is providing investment incentives under its ‘Age-Appropriate Conversion’ programme. In the years 2014–2018, promotional loans and investment grants were used for the conversion of 190,000 homes. A recent evaluation has found the promotion to be effective. By far the largest number of measures implemented were those which the research literature has identified as being crucial to accident prevention and independent living – reducing thresholds and steps, as well as building age-appropriate bathrooms. The primary target group, people with mobility limitations, was also reached very well, mainly because the grant support provided is suitable for elderly and low-income households.
Economics in Brief
Burglaries have been declining for some years but only one quarter of existing dwellings in Germany are sufficiently protected against break-ins. Break-ins not only cause financial losses but also psychological damage. A recent evaluation has shown that some 55,000 existing dwellings are effectively protected against break-ins each year under KfW’s ‘Burglary Protection’ programme. The coronavirus crisis is expected to increase demand for structural burglary protection but income losses will make investments more difficult at the same time.
Full coffers provide a reprieve but the outlook is clouding over
Most municipalities reported a good or even very good budget situation in the KfW Municipal Panel 2019. They were able to plan or even start many investment projects, so according to a nationwide estimate the perceived investment backlog has dropped to around EUR 138 billion, roughly the level of 2015. The surveyed treasuries, however, are significantly more sceptical about their future financial position. Moreover, around one third of investments cannot be realised as planned. So it remains to be seen whether the reduction in the backlog of investment can continue. The KfW Municipal Panel is based on an annual representative survey conducted by the German Institute for Urban Affairs. It covers municipal financial decision-makers in cities, communities and districts and is recognised as an important point of reference in economic policy debate in Germany.
Focus on Economics
The need for climate action and environmental protection requires German municipalities to invest large sums in infrastructure as well. Municipalities are already deploring a significant backlog of investment and it is unclear how they can finance the necessary investments in enhancing sustainability. Green bonds were developed as a financing instrument to meet this challenge but are almost unknown in Germany’s municipalities. In order for this to change, a number of conditions have to be fulfilled.