Analysis: Merkel and Hollande closing the growth gap

BERLIN Thu Apr 26, 2012 9:25am EDT

1 of 2. The European flag is reflected in a window as German Chancellor Angela Merkel waits for the arrival of Grand Duke Henri of Luxembourg at the Chancellery in Berlin, April 24, 2012.

Credit: Reuters/Thomas Peter

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BERLIN (Reuters) - Just over a week before French voters choose their president, a tentative pas de deux has begun between Francois Hollande and Angela Merkel which seems likely to result in a new pact to boost growth in Europe if the Socialist comes out on top.

Until recently, Europe's months-long growth versus austerity drama had cast Merkel in the role of an unyielding Queen of Consolidation and Hollande as an irresponsible Big Spender ready to lead France back to the dark ages of his former mentor Francois Mitterrand, defying financial markets.

But it has become increasingly clear since Hollande edged incumbent Nicolas Sarkozy in a first round vote on Sunday that the differences between the French frontrunner and the German chancellor may be more about style than substance.

In Berlin, a subtle rhetorical shift is evident. No longer are Merkel and her entourage talking about the need for ever-more savings and cuts as the way out of the crisis in southern European economies like Greece and Spain.

"We are not the consolidation Taliban," German Deputy Finance Minister Thomas Steffen told a conference on Wednesday in the German capital.

Hollande, meanwhile, has sent reassuring signals to Merkel that he will not try to re-open the so-called "fiscal compact" on budget discipline that she rammed through a summit of European leaders late last year, nor seek changes to the mandate of the European Central Bank (ECB) as he had threatened.

In a news conference on Wednesday, Hollande laid out four elements of a growth plan he said he would propose to fellow European leaders if elected. They included issuing common European "project bonds" to fund infrastructure, a more robust financing role for the European Investment Bank, a financial transactions tax and more efficient use of EU structural funds.

Of these four, only project bonds are frowned upon by Merkel, a senior German official told Reuters this week, and even these don't appear to be a "red line" for her.

"It is not an ideological opposition to project bonds, but we do have doubts about their utility," the official said, requesting anonymity.

A STEP TOWARDS EACH OTHER

If Hollande defeats Sarkozy in the runoff on May 6, he has vowed to visit Merkel in Berlin on his first trip abroad.

That trip could yield the outlines of a deal to supplement the German-driven "fiscal compact" with a separate pact for growth that contains Hollande's four points alongside German language emphasising the importance of structural economic reforms as a motor for growth, aides on both sides hint.

Even ECB President Mario Draghi is now calling for a "growth compact" on top of the "fiscal compact", which imposes quasi-automatic fines on euro zone countries that fail to meet EU deficit reduction targets.

The central bank's German board member, Joerg Asmussen, sketched out in a newspaper interview on Wednesday how European governments could channel EU funds to promote employment, while also pursuing German-style labor market reforms.

The final touches could be negotiated between European leaders at a June 28-29 summit in Brussels, with the aim of bringing both pacts into force by the end of this year.

"As soon as he is elected, Francois Hollande will meet with Angela Merkel," Jean-Marc Ayrault, a senior Hollande adviser who is tipped as a possible prime minister should he win, told French daily Les Echos on Thursday.

"The project of relaunching growth in Europe will result from a discussion between France and Germany, but not only them. Other partners will want to be involved," he said. "France and Germany must take a step towards each other."

Many would see a new growth pact for Europe as a victory for France and southern Europe over the German-dominated north, but a growth-for-discipline deal is in Merkel's interest too for a number of reasons.

First, it could ease passage of her fiscal compact in EU countries where popular opposition to austerity is on the rise.

Voters in Ireland, for example, may be more inclined to back Merkel's new budget discipline rules in a referendum scheduled for May 31st if they know Europe will soon be complementing them with steps to foster investment.

From a domestic standpoint, jumping on the growth bandwagon also makes sense for Merkel. Her biggest vulnerability in the run-up to a general election next year may be the risk of economic decline in key European trading partners depressing demand in export markets and dragging down German growth.

Unless Merkel is seen to have done all she can to prevent the kind of south-to-north economic contagion Germany has so far avoided, her Social Democrat rivals could paint her as a rigid savings kommissar whose hard line with weaker euro zone states boomeranged.

Merkel's readiness to compromise with Hollande is also based on a conviction that the Socialist will have very little room to stray from Sarkozy's consolidation course, the senior German official said, despite the Socialist's vows to partially unravel pension reforms, raise the minimum wage and put back France's balanced budget goal.

"This is not the 1980s with Francois Mitterrand. They can't afford to get it wrong and then correct themselves this time around," the official said. The former Socialist president took two years to reverse his free-spending economic program in the face of economic crisis in 1983.

"Our view is that financial markets will provide all the discipline we need."

(Writing by Noah Barkin; Additional reporting by Daniel Flynn and Paul Taylor; Editing by Paul Taylor)

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