New German gov't may benefit from a rebound

Federal new borrowing is expected to hit a record 86 billion euros in 2010 and the public sector budget deficit could reach six percent of GDP next year — double European Union limits.

Regardless of whether Merkel ends up with the center-right coalition of her choice or Germany gets what polls suggest is the other most likely outcome, another “grand coalition” with the Social Democrats (SPD), a key task of the next government will be to tackle this budget hole.

The strong rebound forecast by some economists could gird the economy against big job losses, cut the borrowing need and help Berlin rein in the deficit faster.

Economists at Allianz now believe GDP could shrink by as little as 4.1 percent in 2009. The government has budgeted for a 6 percent fall.

That could open the door to tax cuts favored by Merkel's conservatives and the FDP. While the parties differ on how substantial any relief should be, both see scope for an easing of income, corporate and inheritance tax.

“If upbeat forecasts are right and Merkel gets a coalition with the FDP, they'll look to press ahead with tax cuts,” said Gero Neugebauer of Berlin's Free University.

Tax relief could help strengthen domestic demand, but the key growth driver in any recovery is likely to come from abroad.

Volker Treier, chief economist of the German chamber of industry and commerce (DIHK), says key trading partners in Europe and beyond are showing resilience. In June, German exports posted their biggest monthly rise in nearly three years.

“Looking at Asia, there are signs of a pick-up. Even in the United States, the picture is brightening,” Trier said.

Risks to the outlook remain, notably Germany's fragile banks. The government fears they could rein in lending to consumers and small-to-medium sized companies next year and is already thinking about steps to counter that.

If the optimists are right, however, the next government may find that the measures already introduced to get the economy going are sufficient, said Rosenstock at Gebser & Partner.

“Merkel won't need to do anything but keep calm,” he said. “Her main task will be to hold a steady course and avoid doing anything stupid. I have the impression she's understood that.”

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