Germany Cleans Up Its Act

No longer the euro zone's black sheep, the continent's largest economy has wrestled its budget deficit back within the EU's official limits

Germany is legal again. After violating the European fiscal speed limit for five years in a row, Germany's budget deficit is on track to dip below 3% of gross domestic product for 2006, according to the most recent official figures, released late last month. The nation will again fulfill the conditions that European countries—at Germany's insistence, ironically enough—agreed upon before creating the euro common currency in 1999.

Hurrah. But what, if anything, does Germany's newfound budgetary health mean for the European economy? To hear the economists tell it, not that much. European leaders originally set the 3% limit for reasons that were more political than economic.

In particular German leaders wanted to reassure their reluctant citizens that the euro would be as solid as the Deutschemark—never mind that Germany went on to be the biggest violator of the agreement. "I don't even know if there was an economic rationale," says Wolfgang Leim, an economist with Dresdner Bank in Frankfurt.


  Still, Germany's compliance with the monetary union treaty could have some important beneficial effects. The nations who use the still-young common currency must demonstrate budget discipline in order to ensure the euro's long-term credibility. "The solidity of government finances has a long-term effect on the stock market, even if it's hard to quantify," says Tammo Greetfeld, equity strategist at HVB Group in Munich.

More important, Germany's adherence to the budget limits is another sign that the nation is slowly shaking off a decade of economic malaise. Germany's budget sloppiness has been an embarrassment. Along with double-digit unemployment and tepid growth, the chronic fiscal overdrafts told the world that once-mighty Germany had become the weak link of Europe.

Now unemployment is edging downward, growth is up, and Germany's exporters are thriving. Even consumer spending has shown some life this year, thanks in part to the soccer World Cup held in Germany in July.


  Klaus Kleinfeld, CEO of Munich electronics and engineering giant Siemens (SI), is among those who thinks the good mood created by the championship could have a lasting effect on the economy. "It could be a catalyst," Kleinfeld told "It shows the country knows that it has to change and knows that it has to compete internationally."

Chancellor Angela Merkel's government is proving to be another positive. The grand coalition of Merkel's center-right Christian Democrats and the center-left Social Democrats hasn't embarked on the radical reform of labor regulations that business wants. But the government is likely to cut the corporate tax rate to about 30% from 39%, making Germany a more attractive place to invest.

The governing coalition has also avoided the infighting and erratic policymaking that plagued Merkel's predecessor, Gerhard Schröder. "The government should get credit for cultivating a calm and pragmatic style," Dresdner Bank chief economist Michael Heise wrote in a recent note to investors.


  To be sure, economists and businesspeople are holding their euphoria in check. Germany's fiscal recovery stems largely from record corporate profits, which boosted tax receipts, rather than from budget discipline. Most economists expect the German and euro-zone economies to slow next year, which will again put pressure on the budget.

Dresdner forecasts growth in euroland to fall to 1.9% in 2007 after 2.2% this year. For Germany, Dresdner sees growth slowing to 1.2% in 2007 from 2.2%. In August the closely watched IFO Institute's survey of economic confidence fell to its lowest point since December, a worrying sign.

Even as Merkel's government cuts corporate taxes, it is sticking with plans to boost the value-added tax to 19% from 16% beginning on Jan. 1, 2007. Payroll deductions for pensions and health care will also rise. Those measures will hurt consumer spending and could trim one percentage point from growth in German gross domestic product, says Carsten Klude, equity strategist at private bank M.M. Warburg in Hamburg. "The positive effects are canceled out," Klude says.

Germany still has a lot of work to do. But at least the task will be easier now that the nation is no longer Europe's leading fiscal deadbeat.

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