(Adds comments from German Finance Minister)
By Michelle Martin
BERLIN Aug 28 After ramming austerity medicine
down the throats of smaller euro zone countries for the past
four years, Germany is showing clemency towards its closest
Dubbed 'KRANKreich' or 'ill empire' - a pun on the German
word for France - by mass-selling daily Bild, Germany is worried
by its neighbour's health, not least because the Ukraine crisis
to the east is hurting its own economy.
The last thing Germany needs is deeper trouble to its west.
The upshot is that Berlin is willing to cut Paris some slack
in the form of a quid pro quo: a commitment by French President
Francois Hollande to implement reforms is likely to see Germany
give him more time to put France's public finances in order.
Germany is encouraged by Hollande's shake-up of his
government this week and the commitment to push ahead with
reforms and spending cuts.
The Socialist, the most unpopular French president in over
half a century, has ousted maverick Economy Minister Arnaud
Montebourg over a tirade against Germany's "obsession" with
austerity, and shown he is finally prepared to tackle sceptics.
Speaking in Paris on Thursday, German Finance Minister
Wolfgang Schaeuble said he agreed with Hollande that public and
private investment was needed to boost growth.
"I think that we are pushing in the same direction," he said
at a news conference with his French counterpart Michel Sapin,
who stayed on after the cabinet reshuffle to continue the role
in which he has tried to convince EU partners France will fix
its public finances.
Carsten Schneider, a senior member of the Social Democrats
who share power with Chancellor Angela Merkel's Christian
Democrats, stressed the importance of France implementing rather
than just announcing reforms. But he hinted at some help.
"We have a vital interest, whether we're Social or Christian
Democrats, in France getting back on its feet," he said.
"I can only cross my fingers that (French Prime Minister
Manuel) Valls will now get support for his reforms. We need to
support France in that so it remains stable," he added.
Germany has already shown some signs of softening the tough
stance on fiscal discipline it took during the early years of
the euro zone crisis.
Last year, Berlin shifted its focus to "growth-friendly
consolidation", whereby it continues to encourage countries to
balance their budgets and cut deficits, but also to take
measures to tackle unemployment and boost growth.
The German government is also tolerating higher wages in
Germany, potentially boosting domestic demand and reducing its
relative competitiveness, a fillip for other euro zone
Momentum is also building for greater fiscal leniency after
European Central Bank President Mario Draghi, in a landmark
speech last Friday, put more emphasis on fiscal stimulus than
austerity by calling for governments to boost demand.
Draghi's speech picked up on a drive away from austerity
that is being led by Italian Prime Minister Matteo Renzi.
Under pressure from Renzi, European leaders agreed in June
to make "best use" of the flexibility built into the euro zone's
fiscal rules - as long as countries carry out reforms.
Another game-changing factor is the macroeconomic backdrop.
Until earlier this year, the German economic juggernaut had
forged ahead despite problems elsewhere in the euro zone. But a
contraction in Germany in the second quarter, slowing inflation,
and the dampening effect of the Ukraine crisis on European
business has strengthened the case for greater fiscal leniency.
On Thursday Schaeuble said crises abroad and signs of an
economic slowdown meant it was "important to stay the course" on
investment, adding that increasing investment and improving the
legal framework for it would be one of the main subjects of
discussion when European ministers meet in Milan next month.
Hollande's stated determination to undertake reforms is
likely to give Berlin the reassurance it needs to loosen the
fiscal reins slightly. This could come in the form of a new
let-off for France.
France has already been granted a two-year reprieve to get
its deficit in line in 2015. It says it will press ahead with a
50-billion euro spending cut for 2015-2017 but go no further.
Norbert Barthle, budget committee leader for the German
Christian Democrats (CDU), told Reuters France was Germany's
"biggest headache" and he hoped the government crisis would put
pressure on Hollande to carry out announced reforms.
But he suggested Germany would agree to give France another
reprieve to bring its deficit under the EU's 3 percent ceiling.
Barthle said another extension "will only be acceptable if
the EU Commission says clearly what is expected of France. We
assume that France to stick to the things it has signed,
including the fiscal pact."
EU rules stipulate that governments must aim for a budget
close to balance or in surplus and they also have to reduce
public debt. But the rules also say governments can get more
time to achieve a balanced budget if they implement reforms that
have a demonstrable positive impact on growth.
Marcel Fratzscher, president of the DIW economic institute,
said France was unlikely to be able to bring its deficit below 3
percent of GDP before 2016 so Germany would probably have little
choice but to agree to give France more time.
"The German government knows that, so the issue will be more
what the French government commits to in return - if it can
really prove it's making a lot of progress on structural reforms
there may be more willingness," he said.
Germany may offer France some concessions but it does not
want to be taken for a ride.
To guard against any slippage, Berlin is still keen to
maintain pressure on euro zone strugglers to cut their deficits
and work towards budget balance to avoid opening the flood gates
to more lax fiscal policy.
"The danger is that France, possibly with Italy, will tear
down from behind what we have worked so hard to build," one
senior German official said.
Martin Koopmann, managing director of the Genshagen
Foundation, an institute for German-French cooperation in
Europe, said the German government would approach France's
problems with "a significant dose of pragmatism" and probably
reluctantly give it another extension.
Ultimately, Germany has a vested interest in not squeezing
too hard on France, which is its biggest export market.
While Germany will continue to call for countries to stick
to structural reforms and achieve balanced budgets, its
dependence on European demand for its products meant it could
not afford to be too harsh on France, said Koopmann.
"It's not in Germany's interests to bring France to its
knees with an excessive austerity policy - it's more a question
of reforming France and even if that takes ages, the main aim
will be to win back France as a strong sales market," he added.
(Additional reporting by Matthias Sobolewski in Berlin and
Leigh Thomas in Paris; Editing by Paul Carrel and Tom Heneghan)