FILE PHOTO: The skyline with the banking district is seen during sunset in Frankfurt, Germany, February 27, 2024. REUTERS/Kai Pfaffenbach/File Photo

By Maria Martinez

BERLIN (Reuters) -Germany's landmark reform of its fiscal rules earlier this year has set the stage for economic recovery, but medium-term prospects remain constrained, the International Monetary Fund said on Wednesday in a report.

Germany was the only member of the G7 advanced economies that failed to grow for the last two years, and only modest growth of 0.2% is expected this year, according to the IMF forecasts.

Plans by Germany's new government to sharply increase spending on infrastructure and defence are expected to prop up growth, driven by a gradual acceleration of domestic investment and consumption, the IMF said, forecasting real GDP growth of around 1.0% in 2026 and 1.5% in 2027.

The deficit is projected to widen to about 4% of GDP by 2027 and debt is projected to rise to around 68% of GDP by 2027, still the lowest among G7 economies.

Despite the fiscal boost, medium-term prospects remain constrained by rapid population aging and subdued productivity growth, according to the report.

Economists said the fiscal space now available must be used judiciously to boost the economy's longer-term productive capacity and be complemented by pro-growth structural reforms.

Those could include measures to foster more innovation and digitalization, cut red tape, reduce labour supply constraints and deepen European economic integration, they said.

(Reporting by Maria Martinez, Editing by Miranda Murray)