Interest rate turnaround costs municipalities billions

In the fight against high inflation rates, the central banks have heralded the turnaround in interest rates. This means that times are getting tougher for debtors – including German municipalities. Because refinancing their current investment loans is becoming increasingly expensive. “According to our calculations, the interest burden is likely to be more than 3.2 billion euros higher this year,” says Sebastian Bergmann, Managing Director of EDS European Debt Solutions GmbH.

Low interest rates have made municipal debt quite cheap in recent years. But in view of the increased inflation rate, the central banks have stepped on the monetary policy brakes. The US central bank, the Fed, made the first move in March and has since raised its effective key interest rate from 0.08 to 3.08 per cent. Since July, the European Central Bank has followed suit: Its interest rate for main refinancing operations has risen from zero to two per cent. Further interest rate increases are to be expected.

This makes debt more expensive for the federal government. While the yield on ten-year German government bonds was still negative in March, it is now at two per cent. “And this is also having an impact on German municipalities, which are facing higher interest expenses,” says Bergmann. Based on the 2021 municipal debt, municipalities had taken out investment loans of 130.4 billion euros. According to the EDS analysis, the average duration of the loans was 10.45 years, so the loans have to be refinanced every 10.45 years. “This results in an annual refinancing requirement for the investment loans of 12.48 billion euros,” Bergmann explains.

Against this background, EDS compares the interest burdens of two points in time: 1 January 2022 versus 1 October 2022. The lending of investment loans with five-, ten-, 20- and 30-year terms is analysed here. An amortising interest rate of 75 percent and a bullet interest rate of 25 percent are assumed.

The result: while interest rates at the beginning of the year were 1.51 to 1.66 percent, depending on the term, they had risen to 3.29 to 3.45 percent by the beginning of October. The interest rate on ten-year loans, which account for the largest share, increased from 1.47 to 3.25 per cent. In total, this increase leads to refinancing costs rising from around 2.10 billion euros to 5.35 billion euros. “The turnaround in interest rates has also made investment loans, which are so important for the municipalities, significantly more expensive,” says Bergmann. And thus narrows the room for manoeuvre of the treasurers.