FACTBOX-Key political risks to watch in Germany

BERLIN Mon Aug 2, 2010 7:49am EDT

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BERLIN Aug 2 (Reuters) - Chancellor Angela Merkel must galvanise her ruling coalition to deliver on reform promises, and end political infighting that has sapped her poll ratings and weakened the government.

Over the past month, Merkel's centre-right alliance has lost its majority in the Bundesrat upper house of parliament, and the chancellor has been faced with some of the most negative headlines of her career after a rebellion over the election of a new president.

The situation is dire. Polls suggest Merkel could lose control of parts of Germany her conservatives have governed for nearly 60 years if she cannot get her second administration back on track just nine months after it took office.

But it appears likely the government will soldier on as neither Merkel's conservatives nor their pro-business Free Democrat (FDP) coalition partners have any desire for early elections -- or new partners.

Coalition lawmakers have said the government must pass key planks of its reform agenda by the end of the year to revive its fortunes before a string of state elections in 2011.

The coalition's woes have worsened despite a raft of data showing the economy has made a vigorous recovery in recent months, with business sentiment posting a record jump in July and unemployment falling to pre-crisis levels.

Following are some of the key factors to watch:

COALITION WOBBLES

Surveys show Merkel's personal ratings have fallen to their lowest level since she took office in 2005, and support for her conservatives has slipped below 30 percent for the first time since 2006.

At the same time, the chancellor has become increasingly isolated, with six top conservatives leaving the stage this year, including Christian Wulff, the former Lower Saxony premier whom Merkel struggled to get elected to the ceremonial post of president.

Polls show the main opposition Social Democrats (SPD) have almost closed the gap on the conservatives, who lost control of Germany's most populous state North Rhine-Westphalia -- and with it, the Bundesrat -- to an SPD-Greens alliance last month.

Through the Bundesrat, the left-wing opposition parties can block or interfere with much of Merkel's planned legislation. A poll last week put combined support for leftist parties in parliament at 58 percent, 24 points ahead of her coalition.

Meanwhile, support for the FDP has dwindled to 4 percent -- below the 5 percent mark needed to enter the federal parliament -- from nearly 15 percent in September.

Foreign Minister Guido Westerwelle, the FDP leader, remains one of the most unpopular figures in the government, and his position at the head of the party could be under threat if it falters in three state elections due in March.

What to watch:

-- Leaders in the coalition backed a proposed health reform just after Wulff's election, but the planned measures were under attack within days from senior party figures. The bill must still pass through parliament, due to reconvene in September.

-- The three states voting in March have a combined population of 17 million people, with Baden-Wuerttemberg by far the biggest. A poll there this week showed support for the SPD and Greens nudging ahead of the FDP and Merkel's Christian Democrats (CDU), who have ruled the wealthy state since 1953.

-- State elections will also be held in Saxony-Anhalt and Rhineland-Palatinate in March, with Bremen, Berlin and Mecklenburg-Vorpommern voting later in the year.

POLICY DISPUTES/IMPASSE

The health reform bill, needed to plug an 11 billion euro funding gap in the state healthcare system next year, is one of three laws coalition lawmakers have said must soon pass.

Extending the lifespan of nuclear power stations remains high on the agenda, though the coalition has yet to resolve disagreements over how far this should go.

The FDP in particular wants to simplify Germany's tax laws, having been thwarted in its efforts to cut taxes.

Disputes are also simmering over plans to find 80 billion euros of savings by 2014, both to underpin the euro currency and meet the strictures of a "debt brake" law requiring Germany to cut the federal deficit-to-GDP ratio to 0.35 percent by 2016.

Some leaders have already pushed for the plans to be pared back amid concern they were hitting the poorest too hard.

The measures under review involve far-reaching military cuts, including putting an effective end to national service, though the coalition has not been able to agree on this.

What to watch:

-- Whether Merkel's coalition is able to get the planned health bill through the Bundestag lower house.

-- The SPD and Greens have vowed to mobilise popular support against an extension to nuclear lifespans, which could put the government on the back foot ahead of next year's elections.

-- How the government copes with competing demands for cash in its efforts to carry out the budgetary cuts.

ECONOMY

Exports and industrial orders have leapt since the start of the year, spurring a revival in the labour market. Several leading think tanks have raised forecasts for growth this year but economists expect the economy to slow in coming months.

Germany relies heavily on exports for growth, which has prompted major trading partners to accuse Berlin of not doing enough to boost its domestic demand. Many will be watching to see whether the labour market pick-up can fuel a revival.

Some economists also say productivity could suffer if firms use a state subsidy for reduced hours for too long, inflating their cost base by artificially protecting the labour market.

What to watch:

-- Germany's economic recovery may start to sputter if demand dries up abroad, and recent surveys have suggested that growth in new export orders is already cooling.

-- If Germany continues to profit from the global rebound and countries such as France fail to gain traction, disputes over economic policy in Europe may intensify.

-- Preliminary second quarter GDP data are due on Aug. 13.

DEBT

Bank bailouts, labour market subsidies and stimulus measures to boost growth have all added to Germany's debt burden.

As Europe's benchmark issuer of sovereign debt, the federal government has seen strong secondary market demand for its bonds, lowering the cost of servicing new borrowing.

However, record low coupons on recent issues have hit demand, as shown by an auction of 30-year bonds on July 21.

At local government level, a number of large western cities are nearing bankruptcy, a situation which may have encouraged the city of Duisburg to host the Love Parade techno music festival that ended in tragedy last month.

Twenty-one people died in a stampede at the festival in Duisburg, one of several heavily indebted western cities whose finances have been further weakened by having to pay towards the redevelopment of the former East Germany until 2019.

What to watch:

-- The deterioration in local finances has deepened splits between Berlin and the regions, and fuelled discontent among westerners who say they have already paid enough for the east.

-- Some leading western politicians have said they will seek to cut the burden on their cities when the law governing the so-called "solidarity charge" for the east is reviewed.

-- Forthcoming bond sales will provide a clearer picture of how demand is holding up. A new 2-year Schatz sale is due on Aug. 11, followed by a new 10-year Bund auction on Aug 18.

For political risks to watch in other countries, please click on [ID:nEMEARISK]

(Editing by Mark Trevelyan)

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