KfW Research: Municipalities perceive worsened financial situation and higher investment backlog

• KfW Municipal Panel 2024 shows municipalities have become much more worried about their finances
• More than half of municipal treasuries view their financial situation as negative, and 90% are pessimistic about the next five years

• Although investment has grown, it cannot keep up with rising prices and needs. Investment backlog has climbed to EUR 186.1 billion

The KfW Municipal Panel 2024 shows that the mood among municipal treasurers has deteriorated considerably. The rising social, staff and material costs in particular pose a long-term challenge for municipal budgets and reduce scope for investment. The survey carried out by the German Institute for Urban Affairs on behalf of KfW Research indicates that cities, communities and rural districts are therefore increasingly worried about their financial situation. Well over half of them – 58% – view it as negative, almost 10 percentage points more than in the previous year. Only 17% of the municipalities surveyed have a positive view, a drop of 6 percentage points on the previous year.

Treasuries are even more pessimistic about the next five years. In addition to current fiscal challenges such as weaker tax revenue growth, rising staff expenditure and growing material expenditure as a result of higher prices or additional social functions, municipalities face structural challenges. Climate change mitigation and adaptation, digitalisation and demographic change require substantial additional investment. Given their budgetary constraints, only around 2% of municipalities still expect their financial situation to improve over the next five years, while the vast majority of 88% holds a rather negative view of the near future.

The concern is that sooner or later these negative expectations of municipal treasurers will reduce investment. For the current year, however, municipalities expect overall investment of EUR 45 billion in their core budgets. Overall, investment plans are now 4.1% higher than in the previous year but without offsetting price increases in the construction sector. Schools continue to be the main investment priority with just under EUR 13 billion, followed by roads with nearly EUR 11 billion. Child daycare as well as fire safety and disaster management follow at some distance with around EUR 4 billion each. Only slightly more than EUR 3 billion is being budgeted for public administrative buildings.

Rising prices combined with further increasing demands on municipal infrastructure have caused the investment backlog perceived by municipalities nationwide to grow to EUR 186.1 billion. That is EUR 20.5 billion or 12.4% more than in the previous year and is essentially driven by the investment areas of roads (+EUR 9.7 billion to EUR 48.3 billion), schools (+EUR 7.3 billion to EUR 54.8 billion) and fire safety and disaster management (+EUR 4.0 billion to EUR 16.3 billion). Further major elements of the investment backlog are administrative buildings with EUR 18.8 billion, child daycare centres with EUR 12.7 billion and sporting facilities with EUR 12.1 billion.

Various barriers are either preventing an increase in municipal investment activity or delaying their realisation. They operate in very different ways. Lack of funds (in 55% of municipalities) or unsuitable promotional funding schemes (43%) are mainly leading to projects not being completed at all or only in a slimmed-down version. Complex and time-consuming procedures and requirements, for their part, are causing delays of more than one year in around 60% of municipalities. The supply shortages and capacity constraints in the construction sector, too, are causing delays in around 60% of municipalities and increasing the originally budgeted costs by around 25% in around half of municipalities. In 56% of affected municipalities, in turn, personnel shortages in development offices are causing severe delays and, in nearly 30% of cases, even preventing projects from being implemented at all. The multitude of barriers calls for different types of solutions, such as simplifying requirements and reducing red tape, strengthening administrative capacities, particularly by digitalising processes, but also improving the financial basis for municipal investment.

Municipalities have hardly changed how they fund their investments since the previous year. Municipal funds make up around half of the funding mix, while the other half is composed primarily of promotional funds (22%) and municipal loans (24%). Because of their dwindling budgetary capacity, half of municipalities expect debt finance to become increasingly important. This falls into a period of sharply higher interest rates. Around 40% of municipalities that took up a loan found the borrowing terms last year to be rather unfavourable or very unfavourable. For the coming year, the vast majority of municipalities remains pessimistic with a view to lending conditions.

In this edition of the Panel, KfW Research has dedicated a special chapter to municipal administrative buildings. Many of these are in need of modernisation and make up the third largest block of the investment backlog, but they are deemed a low investment priority by municipalities. However, there are various reasons that administrative buildings should be in modern condition. For example, 81% of municipalities see a link between the condition of town halls and the impression which citizens have of the state.

“The ongoing crises and economic uncertainties have affected sentiment in rural districts, cities and communities. Nine out of ten municipalities are pessimistic about how their financial position will develop in the next five years. At the same time, the perceived investment backlog has grown to more than EUR 186 billion”,

said Dr Fritzi Köhler-Geib, Chief Economist of KfW.

“Still, investment is key for municipalities to be able to contribute to the provision of public services and the transformation. It is also important in this regard to be aware that municipalities account for around 60% of public construction measures. In times of budgetary constraints, there is a need to address the many non-monetary obstacles, for instance by simplifying approval and awarding procedures so that at least the available investment funds can be used more quickly and efficiently.”

The KfW Municipal Panel can be downloaded from www.kfw.de/kommunalpanel.

The dataset:

The KfW Municipal Panel is based on an annual survey of treasuries of cities and communities with more than 2,000 inhabitants and of all rural districts. The nationwide representative study is carried out annually by the German Institute for Urban Affairs (Difu) on behalf of KfW Research since the year 2009. The survey for the current edition ran from September to November 2023. Responses were received from 799 municipalities.