Analysis: Germany is the largest economy in Europe.. What if it starts to move to the left?

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LONDON, UK (CNN Business)– Angela Merkel is preparing to step down as German chancellor after 16 years, ushering in a new era for Europe’s largest economy.

It is difficult to predict the results of the elections on Sunday, and it may take weeks or months to know the performance of the new government.

But when things clear up, opinion polls suggest the new chancellor could be left-leaning SPD leader Olaf Scholz. And Schulz is the one who led the German economy during the Corona pandemic as Finance Minister in alliance with Merkel. The Green Party may more than double the number of Parliament.

Schulz’s party and the Greens are expected to ally themselves with the business-supporting FDP, providing them with enough leverage to shift the country’s economic agenda to the left.

Taxes and spending could rise as political leaders plan to double down on digitalization and climate policies. The rising government debt may not be a priority for the next government.

“The alliance between greens and liberals will bring the latest innovation forces, which a German government has not seen for some time,” says Karsten Brzeski, director of macroeconomic research at ING.

Increased spending and anxiety about the aftermath

Global banks are indicating that the final outcome of the parties’ post-election maneuvers are not certain, and advise investors to prepare for two possible outcomes: an alliance between the SPD, the Greens and the FDP, or a narrow victory for Merkel’s centre-right party, the Christian Democratic Union (CDU). Armin Laschet, who may need to ally with the Green Party and the Free Democratic Party.

The latter option may come with the left, but it is less dramatic than the alliance between the SPD, the Greens, and the left. Analysts have played down the possibility of this outcome, which may also surprise investors, as it leads to more ambitious wealth redistribution and taxation efforts.

Regardless of which coalition takes over, it will have to manage the ongoing economic recovery from the coronavirus pandemic. The German economy is expected to grow by 2.9% this year and 4.6% next year, after a 4.9% contraction in 2020, according to the latest forecasts issued by the Organization for Economic Cooperation and Development.

But recent data shows that momentum is waning, as the Ifo index, which monitors the country’s business climate, fell for the third consecutive month in September, according to data released Friday.

Slower growth in China, lower supply chain and higher natural gas prices are likely to have many negative effects.

This drop may increase pressure on the country’s new leaders to repeal strict fiscal laws in order to continue spending on the local economy.

The country had imposed what it called the “debt brake” stipulated in the constitution in 2009, after the financial crisis with the exception of some occasions. Because of the pandemic, debt laws were suspended until 2023, allowing Germans to borrow more, as the debt-to-GDP ratio rose by 70% in 2020.

But while this percentage is small when compared to the United States, where debt is expected to exceed annual GDP, German centrist parties are looking to keep the public finances under control. The Green Party is seeking to relax the laws of religion.

UBS strategists Dean Turner and Maximilin Kinkel believe the “debt brake” that has become the guiding principle of German fiscal conservatism may still be in effect since repealing it would require a two-thirds majority in parliament.

They believe Germany’s new leaders will find other ways to increase spending to tackle climate change, an issue that took on greater importance after the country was hit by floods in July.

“What all parties have in common is the need to tackle climate change,” Turner and Kunkle wrote in a research report. Regardless of which coalition wins, “investment in the environment will rise.”

tackling climate change

Barzaki expects that the next ruling coalition, whatever its composition, will result in a distinctive investment tool, to avoid the “debt brake”, which will allow the flow of funds for green initiatives.

Some of the timetables may be changed by a more liberal coalition government.

“They (the greens) are likely to push the German economy to speed up the transition to green energy as a condition of participation in government,” according to a report prepared by Goldman Sachs for its clients.

The Green Party has called for a 70 percent reduction in greenhouse gas emissions from 1990 to 2030 levels, compared to the current government’s target of 65 percent.

He also wants to close coal plants by the end of the decade, not 2038, and no new cars to emit any gas by then either.

This could provoke a clash with Germany’s most influential sectors of business. In the latest update of its strategy, German Volkswagen announced that 50% of its sales will come from electric cars by 2030, and this percentage will reach 100% in 2040.

The extent of the state’s intervention in this matter may result in some sensitivities among the members of the coalition.

“The biggest debate will be: How do you change people’s behavior? Do you do it through incentives, or through education, or by raising prices and costs?”

A left-leaning government in Germany could mean raising taxes on the richest Germans, with the SPD proposing a new tax on the super-rich.

But the banks stress that it is not clear how the elections will go, and the CDU may win, making Germany more conservative on its current financial and economic trajectory.





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