Cabinet Approves German Budget Cuts as Euro Governments Struggle With Debt

German Chancellor Angela Merkel’s Cabinet approved a four-year package of budget cuts, stepping up pressure on fellow European governments to reduce debt that risks tearing apart the euro area.

Ministers meeting in Berlin today backed spending cuts and revenue-raising measures worth 81.6 billion euros ($103 billion) from 2011 through 2014. Snubbing President Barack Obama’s calls to focus on economic growth, Merkel says the cuts, equivalent to about 2.7 percent of gross domestic product in Europe’s biggest economy last year, aren’t deep enough to threaten the recovery.

“Germany feels the responsibility to signal that it will continue to push strongly for fiscal discipline within the euro area,” Marco Annunziata, chief European economist at UniCredit Group in London, said in a telephone interview. “The only way to do it is to exercise leadership.”

European countries including Italy, Spain and Portugal are slashing budget deficits to thwart a sovereign-debt crisis spreading from Greece that weakened the euro, raised borrowing costs for the most indebted nations and prompted European Union governments to craft a 750 billion-euro aid package in May. The U.K., which is outside the euro area, last month announced tax raises and the biggest public spending cuts since World War II.

Germany’s plan includes a financial-transaction tax on banks of about 2 billion euros per year and a 2.3 billion-euro annual levy on nuclear-power plants as part of what Merkel calls an “unprecedented” round of budget cuts. The package also calls for welfare reductions, cuts in defense spending and a delay in the rebuilding of Berlin’s royal palace.

Scaling Back

“This budget and the mid-term spending plan are heavily influenced by the banking and economic crisis of the last couple of years,” Finance Minister Wolfgang Schaeuble told reporters in Berlin. “We’re setting out to scale back the excessive deficits and ensure our economic development is sustainable.”

German bonds advanced, with the 10-year bund yield dropping to within five basis points of the lowest in a month. Spanish 10-year bonds fell, sending the yield five basis points higher to 4.77 percent, while the Portuguese 10-year yield rose five basis points to 5.49 percent.

The cuts will reduce the federal deficit by about 40 percent during the next five years, Schaeuble said. Underpinning the plan is a constitutional change from 2009 that compels Germany to reduce the deficit to 3 percent of GDP by 2013 to bring it back within EU limits.

Merkel’s Task

“A policy of saving, scaling back deficits that have risen very sharply -- that’s the task we have to accomplish now,” Merkel told RTL television on July 2. The aim is “that the euro is stable and sustainably secured” when rescue programs expire.

The euro fell 0.4 percent to $1.2576 at 2:34 p.m. in Frankfurt.

Merkel is rebuffing criticism from some Group of 20 nations, including U.S. officials and economists, that she’s promoting austerity while the global recovery remains fragile. G-20 leaders meeting in Canada sought to bridge the divide with a June 27 statement calling on industrial nations to halve their deficits by 2013. She called that a “clear exit strategy.”

Deciding between deficit reduction and economic stimulus is a “false dilemma,” Organization for Economic Cooperation and Development Secretary General Angel Gurria said in a Bloomberg Television interview today.

‘Out of the Hole’

“In the medium to long term, there’s absolutely no way you can sustain these deficits and then there’s no amount of stimulus that will get you out of the hole,” he said.

Germany’s budget deficit is forecast to rise to 5.5 percent of GDP this year. While that’s less than half the 13.6 percent of GDP in Greece last year, it’s still almost double EU limits.

The German economy is meanwhile showing signs of recovery: Unemployment fell for a 12th month in June, exports are booming and the DAX index is one of two euro-area equity benchmarks to avoid a decline this year.

Schaeuble indicated in video message posted on the Finance Ministry’s website that net new borrowing this year may be lower than expected, saying the government will take on “more than 60 billion” euros of new debt. That compares with an official borrowing target of 65 billion euros.

Still, combined backing for the coalition parties dropped one percentage point to 35 percent in a Forsa poll today, more than 13 points below their tally in the September election.

“Merkel realizes that German voters are worried about fiscal discipline in the euro zone,” Annunziata said. That’s why she “wants to push euro-zone partners to change the rules of the game.”

To contact the reporter on this story: Tony Czuczka in Berlin at aczuczka@bloomberg.net.

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