Analysis: German growth spurt to steel fiscal tightening urge

BERLIN Fri Aug 13, 2010 10:02am EDT

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BERLIN (Reuters) - Record growth and billions in extra tax revenues are likely to reinforce not weaken German resolve to slash public spending in the run-up to key state elections for Chancellor Angela Merkel next year.

Economic growth of 2.2 percent in the second quarter has raised hopes Europe's largest economy could expand twice as much as the government has forecast this year, sparking calls for Merkel's administration to relax planned austerity measures.

Some in her center-right coalition say the public should enjoy a "dividend" from the growth, but senior policymakers argue that Germany must use the upswing as a tailwind to reach a consolidation target of 80 billion euros in the next four years.

The coalition of conservatives and pro-business Free Democrats (FDP) has struggled to convert plans into reality due to internal bickering, which analysts say must end if the government wants to emerge from a deep slump in popularity.

Merkel has staked great political capital on her ability to lead Europe out of a sovereign debt crisis that has shaken faith in the euro currency, and German insistence on belt-tightening will keep pressure on other euro zone nations to do the same.

"We will not cut one iota from the overall volume of the (80 billion euro) savings package," Norbert Barthle, budget policy spokesman in the Bundestag lower house of parliament for Merkel's Christian Democrats (CDU), told Reuters.

"People understand that when countries get over-indebted the stability of the currency is at risk," he said. "There's nothing people are worried about more than having an unstable currency."

Barthle, like Finance Minister Wolfgang Schaeuble, is a native of Baden-Wuerttemberg, a powerful German state renowned for its financial prudence which goes to the polls in March.

With an economy the size of Poland, Baden-Wuerttemberg has been ruled by Merkel's conservatives for nearly 60 years, though a recent survey showed the center-left opposition polling more support than the governing CDU-FDP coalition there.

If any part of Germany could grasp the need to roll back the state, then it was Baden-Wuerttemberg, said Uwe Andersen, a political scientist at the University of Bochum.

"The mentality of solid finances is rooted in the state. If Merkel lost control there it would be a very bad sign."

"I would urgently advise the government to stick to the consolidation goals," Andersen said. "This may be crucial for the next general election. The coalition must show resolve."

Five other states also hold elections next year.

Having lost control of the Bundesrat upper house of parliament this summer after an electoral reverse in Germany's most populous state, Merkel has suffered a string of negative headlines despite months of upbeat economic data.

"That's the amazing thing," said Gerd Langguth, a political scientist at the University of Bonn and biographer of Merkel. "Nobody has connected the upswing with the government."

GROWTH WINDFALL

Economists now believe the German economy could grow by three percent or more in 2010, and Alfred Boss of the Kiel-based IfW think tank predicted the total tax take could be around 11 billion euros higher both this year and next.

Windfall tax revenues could allow Berlin to cut new borrowing this year and pare back the federal government's fiscal deficit to 0.35 percent of GDP by 2016 -- a goal enshrined by law -- sooner than previously anticipated.

Although the FDP had campaigned on a ticket of tax relief, Merkel has said she sees no scope for tax cuts over the next two years, and the party's Economy Minister Rainer Bruederle said on Friday the growth boost should serve as a fillip for consolidation. [ID:nLDE67C0AI]

If anything, said CDU budgetary expert Barthle, Germany could now try to balance the federal budget even faster.

"The (0.35 percent) is the upper limit, not the goal," he said.

However, the government could still opt to drop more contentious parts of its consolidation plan -- such as a tax on air travel -- if it can make up the savings elsewhere. Much will depend on how the economy performs in coming months.

SLOWDOWN LIKELY

A sharp increase in exports has driven the German upturn, which follows the country's sharpest postwar recession in 2009. However, imports have also risen sharply, raising hopes German demand is pulling the rest of Europe along with it.

Paris has irked Berlin by suggesting it should do more for Europe by boosting domestic consumption, creating a bigger market for exports from other euro zone countries that need new growth sources now the era of ultra-cheap credit is gone.

"Germany is helping the others more than you'd think," said Adolf Rosenstock at Gebser & Partner Asset Management, one of few economists who forecast 2010 growth of 3 percent a year ago.

"The European economy is so interlinked now that we will see positive effects coming from the upswing. It's not true to say Germany is all about exports that don't help others."

Imports to Germany from the euro zone leapt 27 percent in May -- the last month for which these data are available -- the biggest annual jump since the euro was introduced in 1999.

The growth surge should be complimented by higher German wage settlements and investment, said Rosenstock -- but not at the expense of financial consolidation.

Moreover, it is not clear the upswing will last, another reason not to dilute the program of cuts.

"It's very likely the economy is heading for a slower pace," said Peter Bofinger, a member of the government's panel of economic advisers.

"Industry is producing 10 percent less than it was. Hence considerably fewer workers are needed than we have just now, and their overall income is not what it was before. And with capacity not stretched, companies don't need to invest."

(Editing by Mike Peacock)

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