KfW Municipal Panel 2023: Municipalities are defying the crises, but new challenges lie ahead

• Investment backlog rose moderately to EUR 165.6 billion in 2022
• Municipalities rate their financial position more poorly, and their outlook in particular has dimmed
• Impact of interest rate reversal is palpable as financing conditions deteriorate
• Balancing service delivery and transformative functions poses a growing challenge

In financial terms, German municipalities are proving to be remarkably resilient to crises, as highlighted by the KfW Municipal Panel 2023. Despite the multiple crises and the negative outlook that has been associated with them for municipal finances, cities, communities and rural districts were able to close the year 2022 with a fiscal surplus of EUR 2.6 billion. Investments, too, were robust, the perceived investment backlog grew only moderately to EUR 165.6 billion, and funding opportunities remained adequate despite the interest rate reversal. Numerous budgetary risks such as high price increases and rising interest rates, however, are severely clouding municipalities’ expectations for their future financial position and financing conditions. These uncertainties are putting them at risk of falling behind with the transformative tasks they are facing.

Even if the figures which the treasuries presented in the nationally representative KfW survey for 2022 in Frankfurt today generally indicate stability, they also reflect the deep uncertainties of the past year. Around half the treasuries rated their own financial position as good or satisfactory, but the other half described it as merely adequate or unsatisfactory. The outlook for the coming years is much more pessimistic, with 51% expecting a rather unfavourable and 22% even a very adverse development.

One reason for the discrepancy between the fiscal result and their own assessments lies in the vast differences between individual cities, communities and districts, which also show in their ability to manage the crises of the past ten years. Whereas just under half of all municipalities surveyed under the KfW Municipal Panel experienced a “generally rather positive” or even “consistently positive” financial development, the situation worsened in around one third (35%). The group of crisis-prone municipalities in particular exhibited significantly more problems in their financial position and investment opportunities.

Municipalities plan to invest EUR 43.1 billion overall in the year 2023. That is a 4.4% increase on the previous year but well below the current inflation rate. Given the sharp increases in the prices of capital goods and construction measures, the 3.9% increase in the municipalities' perceived investment backlog is rather moderate and now amounts to EUR 165.6 billion (previous year EUR 159 billion). The areas with the greatest needs are school buildings (planned investment of EUR 12.1 billion; investment backlog of EUR 47.4 billion), municipal roads (planned investment of EUR 10.8 billion; backlog of EUR 38.6 billion) and public administrative buildings (planned investment of EUR 2.4 billion; backlog of EUR 19.5 billion).

Owing to the crises, more promotional funds and municipal loans have been used to fund investments for some years now because it has become more difficult for municipalities to plan with their own funds, especially as tax revenues are subject to economic uncertainties. As a result, 25% of investments are currently funded with loans and a further 22% with promotional funds of the federal and state governments. Surpluses from previous years and general public funds make up 20% and 18% respectively, while municipalities additionally receive purpose-tied investment allocations which make up 10%. For the coming years the majority of treasuries (56%) expect a significant increase in debt financing.

Besides economic constraints and budgetary regulations, higher interest rates are also putting limits on debt financing for municipal investments. To be sure, 43% of municipalities regarded borrowing conditions in 2022 as good or very good, but 11% said that conditions were poor or very poor, as opposed to only 2% of municipalities that held this view in the previous year. Especially with a view to the time ahead, rising interest rates are likely to make investment finance more costly for municipalities, 18% of which expect a minor deterioration and even 57% a significant deterioration in credit conditions. This is a clear change from the year 2021, in which only 21% of all municipalities anticipated less favourable conditions. Already, 62% of municipalities are therefore preparing for rising interest rates. Among the measures, various interest rate optimisation approaches were mentioned by 45% of the cities, communities and districts, such as building loan contracts or forward loans or swap agreements for interest rate hedging. Nonetheless, 30% of them are also offsetting cost increases by cutting costs elsewhere in the budget, including investments.

However, further postponing municipal investments would be problematic. Besides clearing the investment backlogs that have accumulated over the past decades, municipalities need to realise their share of investments in Germany’s transformation. Investment in climate change mitigation and adaptation plays a particular role. The focal theme of the KfW Municipal Panel 2023 shows that municipalities spent EUR 3.9 billion – 11% of their total investments – on climate-related measures in 2022. Although that was a large sum, it is estimated that they would have to at least double it to achieve the municipal climate targets. Accordingly, 80% of treasuries expect climate investments to increase in the future. Nonetheless, there is broad scepticism as to whether the efforts will be sufficient. Nearly 60% of cities, communities and districts anticipate that at best, only a small part of the needs can be met under current conditions.

“The various crises that have occurred in close succession show that we need a municipal funding system that enables day-to-day business and the management of transformative challenges such as climate action or digitalisation as well as acute crises all at the same time”, commented Dr Fritzi Köhler-Geib, Chief Economist of KfW, on the occasion of today’s publication of the KfW Municipal Panel 2023. “Financially weak municipalities in particular are forced to put off long-term investments during crises to mitigate acute financial constraints. But amid the multiple challenges, financially strong municipali¬ties, too, are reaching their limits. Given the municipalities' significant investment requirements, this 'either-or' between transformation and crisis management must be avoided and municipal functions and revenues must be better aligned again”, added Köhler-Geib.

The database:

The KfW Municipal Panel is an annual survey conducted by the German Institute for Urban Affairs (Difu) on behalf of KfW Group since 2009. The nationally representative survey is directed at the municipal treasuries of cities with district status, regional districts and district towns with more than 2,000 inhabitants and covers the core areas of municipal finances, investment activity and its funding. This year's focal theme is municipal investment in climate change mitigation and adaptation. The main survey for the KfW Municipal Panel ran from September to December 2022, with 862 municipalities participating.

Further information

The current KfW Municipal Panel 2023 can be downloaded from

www.kfw.de/municipalpanel