GERMANY,S ABOUT FACE: STEEP DOWNTURN PROMPTS

UNCLAS SECTION 01 OF 04 BERLIN 000059 SENSITIVE STATE FOR EEB(NELSON),EEB/IFD/OMA(SAKAUE, WHITTINGTON),EEB/EPPD,DRL/ILCSR AND EUR/AGS LABOR FOR ILAB(BRUMFIELD) TREASURY FOR ICN(KOHLER),IMB(MURDEN,MONROE,CARNES) AND OASIA SIPDIS E.O. 12958: N/A TAGS: EFIN ECON PGOV PREL GM SUBJECT: GERMANY,S ABOUT FACE: STEEP DOWNTURN PROMPTS ROBUST SECOND STIMULUS PACKAGE REF: A. SECSTATE 134459 ¶B. BERLIN 1677 BERLIN 00000059 001.2 OF 004 ¶1. (SBU) SUMMARY. Fresh reports indicating a steep plunge in exports and a sudden rise in unemployment have shocked the German coalition government led by Chancellor Angela Merkel, and pushed it into crisis mode. On January 12, the coalition agreed 50 billion euros worth of new stimulus measures, including additional spending on infrastructure and social benefits, as well as cuts in income taxes and social contributions, little of which was anticipated as recently as December. The Chancellor has also proposed creating a 100 billion euro "Loan and Debt Guarantee Program" to guarantee bank loans to credit-starved firms. Critics are worried the additional spending will increase the federal deficit. Others are concerned the hodgepodge of measures will do little to help Germany's flagging economy, besides retarding the descent into recession. Nevertheless, the wave of state and national elections this year virtually guarantees passage in Germany's lower house, though the proposal's fate in the upper house is less certain. If passed, the measures would not begin to take effect until July 1, with most of the impact back-ended to 2010. This second stimulus package underscores Merkel,s shift away from a focus on eliminating the budget deficit towards fighting the recession. END SUMMARY. DETAILS OF THE SECOND STIMULUS PACKAGE -------------- ¶2. (U) After weeks of internal debate, Chancellor Merkel's coalition agreed on January 12 details of a second stimulus package it claims will be worth 50 billion euros over two years. Together with measures passed in November 2008, the new package brings Germany,s total 2009-2010 fiscal stimulus initiative to around 82 billion euros, or about 1.6 percent of GDP in each of the two years, according to the government. If approved, the package would at face value be Europe's largest in responding to the current crisis, and Germany's biggest since the end of World War II. According to Bundestag (lower chamber) Budget Committee Chairman Otto Fricke (FDP),final approval could come before the Easter recess. Elements of the plan would then begin to take effect on July 1. ¶3. (U) Principle elements of the 50 billion euro proposal include: -- transfers to municipal governments, over two-thirds of which are targeted at education and infrastructure (17.33 billion euros); -- income tax cuts, including a reduction in the lowest rate from 15 to 14 percent and an increase in the tax-free threshold from 7,664 euros to 8,004 euros (8.94 billion euros); -- reduction in health-insurance contributions from 15.5 percent of gross pay to 14.5 percent, and cuts in unemployment insurance payments (12 billion euros); -- family benefits, including a 100 euro-per-child payment for parents (2.3 billion euros); -- extension of state benefits to 18 months for employees obliged to work shorter hours (no estimate available); -- automobile industry assistance, including a 2,500 euro payment for drivers purchasing new, environmentally friendly cars (1.5 billion),and funds for innovation (500 million euros). ¶4. (U) The Chancellor has also proposed the creation of a 100 billion euro "Loan and Debt Guarantee Program" to provide state guarantees to small- and medium-sized enterprises (SMEs) having trouble getting credit. Specifics have yet to be worked out, but indications are the state development bank BERLIN 00000059 002.2 OF 004 KfW would administer the fund. CRITICISM OF THE PLAN -------------- ¶5. (U) Concern that additional stimulus spending will increase the German deficit is widespread. Germany,s new borrowing will surge to 60 billion euros this year, according to the CDU's Budget Committee spokesman Steffen Kampeter, who adds, "We're getting to be like America." According to a forecast published by the CDU/CSU Bundestag group, increased government spending combined with declining tax revenues could push the deficit to 3.5 percent of GDP in 2009 and 4.5 percent by 2010 -- far above the Maastricht Criteria limit of 3 percent. CDU Minister-Presidents Christian Wulff (Lower-Saxony) and Guenther Oettinger (Baden-Wuerttemberg) -) whose views will be reflected in the Bundesrat (upper house) -- have threatened to withhold support for the package if it appears their states will be unduly burdened with new debt. Both are calling for a schedule of specific steps to repay the debt after the crisis is over. ¶6. (U) Some economists are also concerned about the composition of the plan. Deutsche Bank Chief Economist Thomas Mayer notes that as political considerations played a significant role in the design of the plan, its effectiveness is "likely to be less than it could have been." Bank of America's Chief Economist Holger Schmieding agrees. He says the effort to please the CDU/CSU/SPD coalition,s various camps, from free-marketeers and low-tax conservatives to economic nationalists and public-spending advocates, resulted in a &very mixed batch8 of measures that will take a long time to work through the economy. Others doubt the wisdom in favoring the automobile industry when other sectors are in similar straits. ¶7. (SBU) Another common criticism is that the new measures will not take effect until July 1, long after expected further deterioration of the economy. Schmieding worries the stimulus will kick in only late in 2009 and do nothing to help when the recession is at its worst. On the other hand, Chief Economist of the Employers' Association (BDA) Ottheinrich von Weitershausen told Econ Counselor he was not concerned about the timing. A fiscal boost later in the year, when joblessness is expected to be high, might actually prove advantageous. ¶8. (U) Aware of the criticism, Chancellor Merkel has called the new stimulus package an "exceptional measure" to help the country weather the financial crisis. She said, "The state is called upon to ensure that market forces will work again." To counter criticism regarding increasing the federal deficit, the Chancellor said she would seek a constitutional amendment to ban public borrowing beyond 0.5 percent in "normal times." She defended support for the car industry by calling it "the core substance of German industry." ¶9. (U) Although the Bundestag is expected to approve the stimulus proposal without major changes, passage by the Bundesrat, which represents the 16 German states, is less certain. Opposition FDP Chairman Guido Westerwelle has said, "This is not an economic stimulus package, but a debt package." If the upcoming Hesse state parliament elections result in a CDU/FDP coalition as expected, Merkel's coalition will need to compromise with the FDP in order to achieve passage in the Bundesrat. In the event, Westerwelle later conceded the FDP would play ball in negotiations over the stimulus package, though the FDP will try to ensure tax reform is part of the deal. MERKEL'S ABOUT FACE -------------- ¶10. (U) The new stimulus proposal underscores Chancellor Merkel,s apparent shift away from a focus on eliminating the budget deficit towards fighting Germany's worst post-war recession. As recently as December, Chancellor Merkel and BERLIN 00000059 003.2 OF 004 Finance Minister Steinbrueck were ridiculing calls for a second stimulus package. Not only would deficit spending today saddle future generations with debt, they argued, but traditional stimulus plans do not work in Germany (REF B). In the end, however, deteriorating economic conditions -- exports plunged more than 10 percent from October to November 2008, and unemployment increased in December for the first time in nearly three years -- plus intense political pressure left Chancellor Merkel with little choice but to change tack. In doing so, Merkel called it "the most difficult domestic political decision that I have taken as Chancellor." ¶11. (SBU) Horst Classen, a top economic advisor to the Chancellor, provided EMIN with some context to Merkel's about face. He confirmed that the economic downturn was consuming most of the Chancellery's time these days, with top advisors pulling all-nighters over the Christmas holidays. The huge drop in exports (the mainstay of the German economy) in particular had left Chancellery officials breathless, Classen said, adding that the government feared the recent rise in unemployment was a sign of things much worse to come. ¶12. (SBU) Classen also conceded politics played a role in shifting the debate in the direction of a larger stimulus package. With the Hesse state elections on January 18, several more in August and September, and national elections in September, the parties of the coalition were scrambling to get spending proposals on the table, he said. The upshot is a second stimulus proposal that is quite large and contains a little something for everyone -- "a smorgasbord", he said. Vice Chancellor and Foreign Minister Frank-Walter Steinmeier, who up to now had followed the lead of his fellow SPD Finance Minister Steinbrueck, reportedly sought to muzzle Steinbrueck. For the sake of the party and coalition unity Steinbrueck toned down his strident criticism of deficit spending. Classen contended the 50 billion euro price tag represented hard numbers; the budget deficit for 2009-2010 would in fact increase by roughly 50 to 60 billion euros as a result of the plan's tax and spending provisions. He acknowledged this could eventually push Germany up against the Maastricht Criteria. ¶13. (SBU) Separately, senior Deutsche Bank analysts told EMIN the second stimulus plan represented a major step in the right direction. They pointed out, however, that the fiscal boost may amount to only 20 billion in 2009, with the remainder coming in 2010. Moreover, much of the spending represents infrastructure projects (bridges, telecom) that will take many months if not longer to complete. COMMENT -------------- ¶14. (SBU) Despite Classen's assurances, the stimulus package's headline figure of 50 billion euros merits scrutiny. After all, the government still ascribes a value of 32 billion euros to the November package, though private analysts put the real figure at around 12 billion euros over two years (2009-2010). The latter discrepancy is due to several factors, including the fact that the government's numbers encompass spending that was already in the pipeline. Some politicians also have a certain fondness for rolling in "multiplier effects." ¶15. (SBU) The differing figures moreover reflect conflicting political imperatives that may become more pronounced as the elections approach. On the one hand, voices for bold fiscal action have grown louder. On the other, deficit hawks, including Finance Minister Steinbrueck, continue to argue for fiscal discipline (if somewhat more quietly). There is therefore a tendency for the Chancellor and others to tout the large size of the stimulus package publicly, while at the same time trying to limit the actual damage to the federal budget. These conflicting forces are still very much at work, and will probably ensure the numbers game continues as the debate moves to the parliament. BERLIN 00000059 004.2 OF 004 ¶16. (U) This cable was coordinated with ConGen Frankfurt. Koenig