Hopes are growing that the stricken Mediterranean nation’s catastrophic depression might finally be bottoming out, thanks, in part, to a boost from tourism. By some early estimates the economy eked out some growth in the second quarter of the year. And the Athens government, after years of savage cuts, seems to be on course to run a primary (ie before interest payments) budget surplus next year.
Yet at the same time it is widely accepted that Greece will require another debt write-down, funded by its eurozone partners, in the near future if it is to put its public finances on a sustainable trajectory. This poses a headache for Ms Merkel, who promised the Bundestag after last year’s second bailout for Greece that Germany would provide no more financial resources for Athens.
Yet the Social Democrats, who seem likely to be Ms Merkel’s coalition partner, have been much less hardline over Greece than her previous partners in the eurosceptic Free Democratic Party. That should make it easier for Ms Merkel to renege on her earlier promise and provide Greece with the assistance that it needs. Holger Schmieding of Berenberg Bank says: “Some reward for Greece’s efforts is likely to find support in Germany’s new political constellation although any new government will also keep the pressure on Greece to continue the reform process.”
Progress on establishing a pan-European banking union has stalled since Mario Draghi managed to calm the financial markets in the summer of 2012 with his “whatever it takes” pledge. The European Central Bank president’s promise to (in extremis) buy up the debt of peripheral states eased the pressure on national leaders to create a credible backstop for their country’s bombed-out banking systems.
That was just as well because Berlin, under the previous coalition, was always unenthusiastic about a banking union even though it had signed up to the principle. Many in her Christian Democrats saw it as a backdoor way of getting German taxpayers to underwrite other eurozone member states.
But the subject has not gone away. A meeting of eurozone finance ministers on 14 October will be asked to approve the European Central Bank as the over-arching supervisor of the bloc’s troubled financial system. That shouldn’t be much of a problem. But with talks on the new coalition in Berlin likely to drag on for weeks or even months, any substantive movement from Germany on sanctioning joint responsibility for the continent’s banking system still looks some way off.
The new Bundestag looks less fixated on austerity as the solution to the eurozone’s woes. The Social Democrats, who won 25 per cent of the national vote, have criticised “excessive” public spending cuts and tax rises imposed on bailed out countries. The SPD has also called for a debt reduction fund to assist crisis-hit countries. Others are even more radical. The Green party, with 8.4 per cent of the vote, has backed eurobonds (or jointly issued debt). The Linke party wants the ECB to finance troubled member states’ debts. But eurobonds and ECB debt financing will not happen, because Ms Merkel’s dominant conservative bloc, which has 41.5 per cent of the votes, is implacably opposed. She might, however, establish a committee to examine the debt reduction fund favoured by SPD.
As well as dealing with Greece, Ms Merkel will soon need to make decisions on Ireland and Portugal. Ireland might be able to fund itself in the markets later this year with the backstop of a stand-by credit line from the eurozone. But Portugal, like Greece, may require another official bailout and the terms of that could be contentious. “Hopes of a change in Merkel’s strategy towards a more overtly pro-bailout stance are greatly exaggerated” said Lena Komileva of G+Economics. “[Her] no-drama strategy of small-sized negotiations linked to incremental conditionality will remain.”
A grand coalition will give the German government a more social democratic complexion. Holger Schmieding at Berenberg Bank expects the election to result in a “modest tilt towards a centre-left agenda at home”. There has been talk of higher income and capital gains taxes, the introduction of more minimum wages for sectors of the economy, and a boost to state capital infrastructure spending. More public spending in Germany, which is still running a sizeable current account surplus, would help the rest of Europe increase exports. But any stimulus is likely to be relatively minor, given the fiscal conservatism of Ms Merkel’s party.
Germany also faces some long-term economic and fiscal challenges, in particular a declining population due to a low birth rate. Immigration is one source of additional labour. But anti-immigrant currents have been building in Germany in recent years. An anti-multicultural tract by a former member of the Bundesbank board, Thilo Sarazin, titled “Germany is abolishing itself”, became a best seller in 2010. Ms Merkel may need to turn this xenophobic sentiment around if she is to cement the foundations of Germany’s continuing prosperity in her third term as Chancellor.