(CNN) – Angela Merkel is set to step down as German Chancellor after 16 years, marking the start of a new era for Europe’s largest economy.
Sunday’s election results are difficult to predict and the formation of a government could take weeks or months to unfold. But when the dust settles, polls indicate the new chancellor could be Olaf Scholz, of the left-wing Social Democratic Party, who led the German economy during the pandemic as finance minister in a coalition with Merkel. Meanwhile, the Greens could more than double their number of seats in Parliament.
Scholz’s SPD and the Greens could team up with the pro-business Free Democratic Party, gaining enough power to shift the country’s economic agenda to the left. Taxation and spending could rise as political leaders redouble their efforts on digitization and climate policy, while mistrust of rising public debt could take a back seat.
“The Greens and the Liberals in a coalition would bring the freshest innovative forces we have had in a German government in some time,” said Carsten Brzeski, global head of macro research at ING.
Spend more, worry later?
Global banks say the final outcome of post-election maneuvers between parties is far from certain, while advising investors to prepare for two potential outcomes: a coalition of the SPD, Green Party and FDP, or a victory cramped from the center of Merkel. the right-wing Christian Democratic Union, led by Armin Laschet, which should also probably ally with the Greens and the FDP.
The first option would mark a turn to the left, but would be less dramatic than an alliance between the SPD, the Greens and the far left Die Linke. This result, which could lead to much more ambitious efforts to redistribute wealth and raise taxes, has been downplayed by analysts and would likely surprise investors.
Whichever combination is supported, it will have to deal with the ongoing recovery after the coronavirus pandemic. Germany’s economy is set to grow 2.9% this year and 4.6% next year after contracting 4.9% in 2020, according to the latest projections from the Cooperation Organization and economic development.
Yet recent data indicates that momentum may be faltering. The Ifo index, which tracks the country’s business climate, fell for the third consecutive month in September, according to data released on Friday. Slower growth in China, edgy supply chains and soaring gas prices are expected to wreak havoc.
The pullback could increase pressure on the country’s new rulers to abandon Germany’s notoriously tight fiscal rules so they can continue spending for the national economy.
The country enshrined a so-called “debt brake” in the constitution in 2009, severely limiting public borrowing after the financial crisis with few exceptions. Due to the pandemic, debt rules were suspended until 2023. This allowed German borrowing to jump, with the country’s debt-to-GDP ratio climbing sharply to 70% in 2020.
Although such a ratio is paltry compared to the United States, where debt is now expected to exceed annual GDP, central German parties have been eager to regain control of the country’s public finances. The Greens, for their part, want a more permanent relaxation of the debt rules.
UBS strategists Dean Turner and Maximilian Kunkel believe the debt brake – which has become a key tenet of German fiscal conservatism – should remain in place, as its cancellation would require a two-thirds majority in parliament .
Nonetheless, they expect Germany’s new leaders to find other ways to increase spending to deal with the climate crisis, an issue that has grown even more prominent after the devastating floods hit the country. in July.
“The one area of ââagreement common to all parties is the need to address climate change,” Turner and Kunkel wrote in a recent research note. Whatever coalition emerges, they continued, green investment “will increase”.
Facing the climate crisis
Brzeski expects the new government coalition, whatever its makeup, will create a special investment vehicle to bypass the debt brake, allowing money to go to green initiatives.
With a more liberal coalition government, however, some deadlines could be brought forward.
“[The Greens] would likely push for an acceleration of the green transition of the German economy as a prerequisite for entry into government, âGoldman Sachs said in a recent note to clients.
The Green Party has called for a 70% reduction in greenhouse gas emissions from 1990 levels by 2030, from the government’s current target of 65%. He also wants coal-fired power plants to shut down by the end of this decade, rather than 2038, and new cars to be emission-free by then as well.
This could create a conflict with the most powerful companies in Germany. In its latest strategy update, Volkswagen said it wants 50% of sales to come from electric cars by 2030, rising to almost 100% by 2040.
The scale of state intervention could generate friction among coalition members.
âThe biggest controversy will be: how do you change people’s behavior? Said Brzeski. “Do you do this by inducing and educating people, or do you do it by [increasing] prices and costs? “
A left-wing government in Germany could also result in higher taxes for the richest Germans, with the SPD proposing a new wealth tax for the super-rich.
But the banks stress that it remains extremely difficult to know how the elections will play out – and that the more conservative CDU could still win, keeping Germany more firmly on its current fiscal and economic trajectory.
This story first appeared on CNN.com “Germany is the largest economy in Europe. What if he moved to the left?“.