BERLIN Jan 4 Europe's sovereign debt crisis and
possible heavy defeats in several of the seven regional
elections in 2011 are two areas of potential trouble for German
Chancellor Angela Merkel and her centre-right government.
The turmoil in her junior coalition partners, the Free
Democrats (FDP), over their steep fall in opinion polls and the
unpopularity of party leader Guido Westerwelle could also
cause turbulence in Merkel's government. [ID:nLDE6BG0OS]
Even though the economy is roaring ahead, with projected
growth of 3.4 percent in 2010 and domestic demand picking up,
the public give the Merkel government no credit for the upturn.
Worries about the euro zone's debt crisis are also lingering.
Following are some of the factors to watch:
EUROPEAN DEBT CRISIS
Merkel and Finance Minister Wolfgang Schaeuble may have
unwittingly exacerbated the sovereign debt crisis that hit
Ireland after engulfing Greece earlier in 2010 with comments
that unnerved markets.
But they had in the back of their minds a German public
sceptical about rescuing profligate euro zone countries when they
insisted that banks and investors should share in the risk of
sovereign bond default from 2013.
It has been a difficult balancing act for Merkel. Under
former chancellor Helmut Kohl, her Christian Democrats (CDU) were
unflinchingly dedicated to European unity, but the German
electorate has since become more volatile and less tolerant
about footing the bills.
What to watch:
- Merkel's public comments about the euro zone debt crisis
may now become more cautious, but her fundamental reservations
are unlikely to change.
STATE ELECTION DEFEATS
The collapse this week of Germany's first and only Christian
Democrat-Greens government in the city-state of Hamburg was
another setback to Merkel, whose conservatives will likely lose
power in Hamburg in a snap February election [ID:nLDE6B00XA].
The CDU also looks like losing the industrial heartland
state of Baden-Wuerttemberg in March, where it has held power
for nearly 60 unbroken years, to a centre-left alliance of the
Greens and Social Democrats.
The coalition has already lost control of the Bundesrat
upper house of parliament after losing a regional election in
May in North Rhine-Westphalia, meaning that left-wing opposition
parties can now block or interfere with much of Merkel's planned
Some analysts warn that the loss of two more key states in
quick succession would cause rumblings in the CDU rank and file.
But they do not expect Merkel to face any serious challenge
to her leadership -- especially because a half dozen potential
rivals took themselves out of politics in 2010.
After slumping for much of 2010, her conservatives have
stabilised in opinion polls lately at about 34 percent, their
level in the 2009 election. But their coalition partners, the
Free Democrats, have plunged to 3-5 percent from almost 15
percent a year ago -- near or below the 5 percent threshold
needed to win seats in parliament.
The opposition SPD and the Greens are both at about 22
percent. The SPD got 23 percent in last year's election and the
Greens were at 10.7 percent. The Left party has been hovering
steady at 10 percent after winning 11.9 percent in 2009.
What to watch:
- The weakness of the FDP under Westerwelle, who is also
foreign minister, will be a source of coalition tension in the
early months of 2011 [ID:nLDE6BE1NX]
- Any sign of rumblings within the CDU about Merkel's
Germany suffered its biggest postwar recession in 2009 when
the economy contracted by 4.7 percent. Driven by exports and
helped by stronger-than-usual consumer sentiment, it emerged
from the slump, leaving many of its euro zone peers trailing.
Hurdles do remain for the export sector, however,
traditionally the economy's main growth engine.
An expected slowdown in global growth next year will likely
reverberate in German industry, although it is not yet clear to
what extent. Germany's specialised products are likely to remain
in high demand in emerging markets.
Economists expect rising domestic investment and private
consumption to help drive the economy in 2011, and many have
raised their growth forecasts for this year and next.
The Bundesbank now sees the economy growing 3.6 percent in
2010 and r%aching pre-crisis levels by 2011. The government
expects growth of 3.4 percent in 2010 and 1.8 in 2011, although
other private sector economists have an even brighter outlook.
The forecasts reflect growing evidence that the domestic
economy is contributing more to the recovery as confidence
Consumer morale rose going into December to its highest
since October 2007, and retailers expect the strong growth in
sales during the Christmas shopping season to extend into 2011.
Germany's stronger-than-expected recovery has helped to pull
the euro zone along in recent quarters, but it also raises
concerns that divergence from struggling states on the periphery
may complicate policy making for the bloc as a whole.
What to watch:
-- Domestic consumption and investment trends will be
important areas to monitor as foreign demand slows; if Germany
manages to diversify its sources of growth further, it could
prove better insulated from any external slowdowns.
-- If unemployment continues to fall, this should continue
to support growth in consumer spending.
-- If Germany continues to profit from the global rebound
and other big countries such as France fail to benefit as much,
disputes over economic policy in Europe may intensify.
Bank bailouts, labour market subsidies and stimulus measures
to boost growth have all added to Germany's debt burden, which
will be the largest in its post-war history.
European Union data collected by Eurostat suggest that total
debt will hit 1.9 trillion euros in 2010, or 75.4 percent of
gross domestic product. Germany is still considered the top safe
haven for bond investors within Europe's single currency area.
It plans to issue less debt in 2011 due to the strength of
its recovery, and authorities say they are not concerned that
the euro zone debt crisis will raise German borrowing costs.
The secondary market for federal government bonds has seen
generally strong demand, lowering the cost of servicing new
debt. But some issues have seen lacklustre demand, underlining
the fact that Germany is not entirely immune from wider euro
zone debt worries.
Next year marks a turning point for Germany's state
finances, as a new "debt brake" law comes into effect, forcing
the federal government to reduce the gap between its annual
revenue and spending to under 10 billion euros by 2016.
The legislation, which is anchored in the constitution, also
means that Germany's regional states -- known as Laender -- will
probably no longer be able to create new net debt from 2020.
At the local government level, a number of large western
cities are nearing bankruptcy and their finances have been
further weakened by having to contribute to the redevelopment of
the former East Germany until 2019.
What to watch:
-- Auctions early in the year may give a sign of steady
demand for Europe's benchmark debt, or a creeping malaise from
the euro zone's periphery states.
-- Splits between Berlin and the regions could intensify as
federal funding grows scarcer and local services are cut back. A
deterioration in local finances has also fuelled discontent
among westerners who say they have paid enough for the east.
For political risks to watch in other countries, please
click on [ID:nEMEARISK]
(Additional reporting by Brian Rohan; Editing by Kevin Liffey)