KfW Municipal Panel 2022: Crisis as a permanent state?

• Municipalities under strain from COVID-19 pandemic, flood disaster and Ukraine war
• Municipal investment backlog grew to EUR 159.4 billion in 2021
• Rising energy prices are placing additional financial stress on already strained budgets

While German municipalities are still struggling with the effects of the coronavirus crisis and the flood disaster of 2021, the next challenge – overcoming the impact of the Ukraine war – is already foreseeable. The current KfW Municipal Panel 2022 shows that the uncertainties in the budgets of cities, communities and districts are now set to massively increase. The survey, which was conducted by the German Institute for Urban Affairs (Difu) on behalf of KfW Research at the end of last year, revealed that 48 % of municipal treasurers regarded their financial position as “adequate” or even “inadequate”. Only 21 % rated their financial position in the second coronavirus year as “good” or “very good”.

One likely reason for the cautious assessments is the uncertain and uneven development of municipal finances. Not all municipalities have benefited from the most recent public revenue growth, as much of this is due to higher trade tax in structurally strong regions. However, almost all municipalities incur the additional expenditure, for example from higher costs of materials and equipment for their pandemic response. A majority of municipalities therefore expect their budgets to take two to five years to return to normal pre-crisis levels (55 % for revenues and 46 % for expenditures). As a consequence, seven in ten treasurers expect their financial position to continue to worsen in the medium term, while only one in ten expect an improvement. This shows that the outlook has slightly improved on the previous year but remains below the long-term average.

The consequences of the Ukraine war, such as the economic sanctions, were not even taken into account here. A follow-up survey to the KfW Municipal Panel of April 2022 shows that the higher energy prices alone are already having tangible impacts on many municipalities. In the year 2020, according to the survey, heating, electricity and fuel costs made up approx. 1.5 % of municipalities’ expenditure. That proportion rose by around one third to 2 % by 2022. Around half the participating cities, communities and districts responded that these additional burdens were “difficult” (46 %) or even “impossible” (5 %) for them to shoulder, forcing them to make changes to their financial planning. Municipalities are responding to the increased energy prices both by making cuts to other budgetary items and by reducing their energy consumption. They are focusing their measures on the use of renewable energy sources for electricity supply (80 %), reducing consumption by raising energy efficiency (73 %), building expertise on energy efficiency (68 %) and using more alternative heating sources (50 %).

According to the current KfW Municipal Panel, investment expenditure grew moderately to EUR 38.3 billion in 2021 (previous year: EUR 37.5 billion). Most of it went to schools and roads, which accounted to around one fourth each. In their investment planning, the municipalities still expect a minor increase to EUR 40.6 billion for 2022 despite the financial planning risks. But the survey findings for the past year have shown again that around one third of all planned investments are not realised. Furthermore, a significant portion of the increased expenditure plans is attributable to the steep rises in construction prices, so that the planning does not necessarily go hand in hand with more real investment in infrastructure.

As a result of growing needs, higher construction prices and only moderately growing investments, the investment backlog reported by municipalities for 2021 has risen to EUR 159.4 billion (2020: EUR 149.2 billion). Schools (29 %), roads (25 %) and administrative buildings (12 %) are the largest items. The strongest growth in the perceived backlog was in roads (+EUR +5.7 billion), fire and disaster prevention (+EUR +3.8 billion) and administrative buildings (+EUR +3.3 billion). At the same time, the investment gap decreased in areas such as arts and culture, IT, schools and sport. Across all areas of investment, 28 % of municipalities expect the backlog to continue growing in the future, while 36 % expect no change and another 36 % can even imagine that it will shrink.

“Trade tax revenues have grown considerably of late – more than expected. But the saying that not all that glitters is gold applies here as well. The Ukraine war is creating administrative and financial strain for German municipalities. The revenues of many municipalities remain fragile while they are grappling with new pressures in the form of high energy costs, refugee accommodation and continuing increases in construction prices. As was the case at the start of the coronavirus crisis, the question is how sustainable and resilient municipal budgets are in the face of these new risks”, said Dr Fritzi Köhler-Geib, Chief Economist of KfW. “In crises we often see that as budgetary scope decreases municipalities are forced to make cuts in the few discretionary areas where they are still free to make their own decisions. This includes social and cultural functions as well as investment in infrastructure. As a result, they reduce the range of municipal services and experience exponential increases in consequential costs due to worn out infrastructure”, commented Prof Carsten Kühl, director of research and managing director at the German Institute of Urban Affairs.

Municipalities are also under heavy pressure outside the crises. In addition to their mandates to provide general public services, they face the transformative challenges of climate action, demographics and digitalisation, which require comprehensive changes to municipal infrastructure and services. “The current KfW Municipal Panel shows that municipalities are diverting investments in fire and disaster protection or IT equipment for schools. That is understandable after the experiences of the flood disaster and remote learning during the pandemic. But it often comes at the expense of other infrastructure areas such as roads and will create new problems because maintenance and modernisation are insufficient. As municipalities are already unable to ensure many of their basic day-to-day functions, it will become even harder for them to tackle long-term tasks of the future such as climate action and digitalisation”, Kühl explained. “We therefore must make greater efforts to put municipal finances on a strong basis so that municipalities will be able to fully perform their functions in the future irrespective of the overall economic climate”, Köhler-Geib concluded.

The current study can be downloaded from www.kfw.de/kommunalpanel