The German electorate is fed up with its government. Since Gerhard Schröder’s left-leaning SPD–Green coalition came to power seven years ago, the German economy has stagnated, growing at less than 1% a year in three of the past four years. The European Commission is now forecasting just 0.8% real GDP growth this year, the lowest rate in the 25-member EU. After disastrous defeats in elections at the level of the Länder, the states of the German federation, which left the governing coalition in power only at the centre, Schröder has gambled on a snap election. But it is not going to work. The conservative CDU, in company with the Bavarian CSU, continues to ride high in the polls. A Merkel-led centre-right coalition, including the liberal FDP, looks set to win on September 18.
I reckon a centre-right coalition would be the best result for German financial assets and the economy. The CDU–CSU manifesto aims to implement an immediate cut in payroll costs for employers to boost employment. It pledges to cut, from 2007, corporation and personal income tax from 25% to 22%. Under CSU pressure, it also aims to rein in the widening budget deficit presided over by the SPD by immediately raising value-added tax from 16% to 18%, some of which will go straight to helping regional government finances as well as the federal deficit.
The tax cuts will help those German companies that receive much of their revenue from abroad but have high domestic labour costs. For example, Siemens generates 77% of its revenue abroad, but has 38% of staff in Germany. BASF has 80% of sales abroad and more than half its workforce at home.
These are limited reform measures, but it’s a start. A centre-right coalition government under Angela Merkel might not rush as aggressively into reform as many would like. But it will give a huge boost to sentiment on German financial assets.
Under the seven years of the SPD-led coalition, German equities were the worst performers on Europe’s major markets. German index the DAX is up only 3.3% since September 28 1998, when Schröder took office. By contrast, France’s CAC-40 is up 32%. Since Schröder called for an election on 22 May, the stockmarket has risen 11%, outperforming other indexes. That shows the potential of a Merkel victory.
Germany’s economic performance under Schröder has been truly awful. But beneath the surface of political failure (low growth, rising unemployment, government deficits and weak consumer spending), Germany Inc has got on with the job of restructuring and relocating. German industry continues to compete successfully in world markets.
Struggling reform
At the same time, the reform process has struggled on. Taxes have come down, some labour market restrictions have been removed, and social security and pension benefits have been curtailed.
There is still a long way to go, but even these limited measures are beginning to bear fruit. There are signs that the labour market is starting to improve. Job vacancies have risen sharply. Service-sector employment growth is accelerating and is now not far behind the rate of growth in the booming US. Overall retail sales growth remains weak, but auto sales are strong.
With further measures under a centre-right government that will boost employment and eventually reduce the tax burden, the German economy is likely to achieve reasonable growth in 2006/07. The growth gap with the US will narrow in 2006.
So I expect a Merkel victory to set the scene for an equity advance in Germany and for the euro to move back up against the dollar.
David Roche is president of independent Strategy, a London based research firm
