| BERLIN, April 4
BERLIN, April 4 Chancellor Angela Merkel is
facing a turbulent period after a series of election routs, a
bitter internal party battle over nuclear energy and a power
struggle that is convulsing her junior coalition partner.
The euro zone debt crisis is also straining her centre-right
government, which has been heavily criticised in the media and
by the opposition for zig-zag policies, and continues to fall in
voter surveys after 16 months in power.
The economic outlook remains bright, with unemployment
falling to a record low [ID:nLDE72U0RE] and growth slated to
remain robust. The economy's strong performance this year
follows impressive growth of 3.6 percent in 2010 -- the fastest
in two decades [ID:nLDE70A1OB].
Following is a summary of the main risks for Germany:
Merkel, whose conservative Christian Democrats (CDU) have
now been swept from power in the two of four state elections so
far this year, has hit a rough patch.
Guido Westerwelle, the unpopular leader of her coalition
partner Free Democrats (FDP), resigned on Sunday, jumping before
he was pushed but not before he proposed handing control over to
an untested new guard of 30 year-olds he hand-picked.
Although he plans to stay on as foreign minister, some
officials within the party are calling for a cabinet reshuffle
that could also claim the head of Economy Minister Rainer
Bruederle, a member of the FDP old guard.
Long unable to separate herself from her least popular
minister, as Westerwelle became known, Merkel managed to lose
the most popular figure in her cabinet when the defence minister
quit in early March, rattling her government just weeks before
three important regional elections. [ID:nLDE7200Z5]
She had hoped to hold onto Karl-Theodor zu Guttenberg in the
hope of avoiding the batterings at the polls, but a plagiarism
scandal ultimately cost him his job.
The CDU lost the conservative bastion of Baden-Wuerttemberg
on March 27 after 58 straight years of rule. The Greens are set
to lead a state government for the first time with the Social
Democrats (SPD). [ID:nLDE72Q0KS]
The election was overshadowed by worries about nuclear power
following the disaster in Japan [ID:nLDE72Q0LE]. Merkel's
government had strongly backed nuclear power and wrote a law
last year to extend the lifetime of the country's 17 reactors.
That hurt her party and it is now split by a destructive
debate on whether to stick with those plans or pull the plug on
nuclear power, as planned, by 2022 or sooner. It is also divided
over Germany's U.N. abstention on military action in Libya.
There have been rumblings in the CDU about the state
election defeats -- they have now lost power in both Hamburg
[ID:nLDE71K0SU], and Baden-Wuerttemberg while holding onto
Saxony-Anhalt and falling short again in Rhineland-Palatinate.
The good news for Merkel is that the CDU does not lead the
governments of any of the three states holding elections for the
rest of this year and thus cannot lose any more seats in the
Bundesrat, or upper house.
Bremen (May 22), Mecklenburg-Vorpommern (Sept. 4) and Berlin
(Sept. 18) are all controlled by the SPD. The CDU has little
chance of winning any of those states.
What to watch for:
- The row over nuclear energy within the CDU that could
ultimately cost the four nuclear power plant operators E.ON,
RWE, EnBW and Vattenfall Europe hundreds of millions of euros
every year in lost profits.
- Rumblings in the CDU rank and file over Merkel's
- A destabilising leadership shake-up in the FDP that will
likely see plenty of new and inexperienced faces taking over top
posts in both the party and the parliament.
EUROPEAN DEBT CRISIS
The euro debt crisis played a key role in the state
elections. Wary of a backlash from voters, Merkel long resisted
calls to expand the 440-billion euro ($570 billion) European
Financial Stability Facility (EFSF). The FDP was especially
adamant in its opposition to raising the size of the EFSF.
What to watch:
- Merkel's public comments about the euro zone debt crisis
and any change in fundamental reservations about increasing the
Germany suffered its biggest postwar recession in 2009 when
the economy contracted by 4.7 percent. Driven mainly by exports
and helped by a pick-up in domestic demand, it has emerged from
the slump. Business morale is currently at a record high and
consumer sentiment at its most optimistic for years.
As monetary and fiscal stimulus is gradually withdrawn from
the global economy and some euro zone trading partners pursue
strict austerity measures, Germany's red-hot export growth is
expected to cool off and return to a more sustainable level.
Barring any major shocks from China, Germany should remain
one of the pre-eminent suppliers of high-quality capital goods
to dynamic emerging markets looking to improve their
infrastructure and boost productivity.
Many economists argue healthy corporate earnings and a
tightening labour market will mean employers will have to raise
wages to retain skilled workers. This should feed through into
domestic consumption but could fuel inflationary pressures.
Last week, chemical companies agreed to hike wages for the
550,000 Germans employed in the industry by 4.1 percent over a
15 month period -- above the current harmonised annual inflation
rate of 2.2 percent in March.
What to watch:
- Whether demand for German goods among EU trading partners
drops as a result of the sovereign debt crisis
- Whether major export market China, in an attempt to
throttle inflationary pressures from an overheating economy,
ends up suffering a hard landing.
- If unemployment continues to fall, this should support
growth in consumer spending.
Bank bailouts, labour market subsidies and stimulus measures
to boost growth have added to Germany's debt burden, partly
offset by rising tax receipts that have sprung from an economy
that has performed better than expected.
Berlin estimates its total outstanding public debt at 82
percent of overall economic activity, a figure Kiel-based
think-tank IfW estimates will grow to 84.3 percent in 2011 --
well above the Maastricht criteria of 60 percent of GDP.
This year marks a turning point for Germany's state
finances, as a new "debt brake" law comes into effect, forcing
the federal government to reduce the gap between its annual
revenue and spending to under 10 billion euros by 2016.
Government sources say the strong economic recovery means
this target may be hit a year early.
What to watch:
- Auctions should signal continued steady demand for
Europe's benchmark debt, but the market could seek higher
compensation in the coming months to offset inflationary risks.
- Germany officially targets federal net new borrowing of
48.4 billion euros for this year but aims to come in below 40
billion. For 2012 it foresees net new borrowing of 31.5 billion
euros before reducing this to just 13.3 billion by 2015 to
comply with the debt brake law.
For political risks to watch in other countries, please
click on [ID:nEMEARISK]
(Editing by Mark Trevelyan and Sonya Hepinstall)