BERLIN Aug 2 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
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:
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
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
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.
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.
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.
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)