Cablegate: Merkel,Steinbrueck Stand Up for Balanced Budget

DE RUEHRL #1309/01 2670759
P 230759Z SEP 08




E.O. 12356: N/A

1. Summary: On September 16, against a backdrop of the
global financial crisis and increasing demands for domestic
spending, Finance Minister Peer Steinbrueck (SPD)
introduced an FY 2009 budget of 288.4 billion Euros -- the
Grand Coalition's third and last joint budget prior to the
national elections in September 2009. In his Bundestag
presentation, Steinbrueck touted the government's horn for
having lowered the country's deficit to the lowest level
since German unification. The tax windfall from the
economy's robust performance during the last several years
enables the government to increase the budget for defense,
development assistance, education and infrastructure.
However, parliamentarians across the political spectrum
question the feasibility of Steinbrueck's goal of a
balanced budget by 2011, particularly in light of
increasing economic uncertainty and the growing demands for
increased domestic spending as the parties gear up for the
elections. End Summary.

--------------------------------------------- ---------
Reaping the Benefits of Consolidation and Economic Growth
--------------------------------------------- ---------

2. With the cost-saving measures of previous years now
paying off, Steinbrueck announced that the FY 09 budget
would include a deficit of only 10.5 billion euros, a third
of what it had been in 2005. The deficit will be the
lowest since German re-unification in 1990. Steinbrueck
plans to cut the deficit even further (to 6 billion euros)
in the 2010 budget and plans a balanced budget the
following year. (Note: The deficit is with the Federal
Budget; the state and communal entities already reported a
budget surplus last year and will do so again this year).
With 42.5 billion euros, Germany's debt service still makes
up the second biggest line item in the budget.

3. Germany's FY-09 budget of 288.4 billion euros marks an
increase of just 1.5%, one of the smallest in recent years.
Germany's solid economic growth of more than 2% in 2007 and
the significantly improved financial condition of Germany's
various social welfare funds provided Steinbrueck even made
some additional spending possible. The defense budget will
receive 1.9 billion euros more compared to 2008, the
Ministry for Development Assistance will see an increase of
800 million euros, and the budget for research and
development will increase by 1.25 billion.

Uncertainties from the Financial Crisis

4. The budget debate took place under the growing gloom of
international financial crisis and concerns over its
possible spill-over into the German economy. In her
September 17 budget speech to the Bundestag, Chancellor
Merkel renewed her call for tighter regulatory control of
the international financial system. She said rating
agencies that assess companies' financial health should be
subject to a code of conduct. She did not repeat her
earlier proposal for a European rating agency. Merkel also
attempted to calm the public, saying that the effect on the
German economy from the current crisis had been "moderate."
(Note: Since then Merkel has used several campaign-related
events to publicly call upon the U.S. and Britain to
confront their serious shortcomings in financial regulation
and has continued to stress tougher regulations and
transparency in international finance markets as well as
unspecified oversight of ratings agencies.)

5. Finance Minister Steinbrueck was more direct. While
defending the underlying assumptions of his budget
(especially the growth rate of 1.7% for 2008 and 1.2% for
2009), he warned that Germany would not escape the
financial crisis completely, but also warned against the
creation of a stimulus package, saying this "would only be
money burned." (NOTE: Over the weekend of September 20-21,
he downgraded the estimate for 2009 to 0.5%, and the
prediction of 1.7% looks increasingly dubious.)
Steinbrueck argued that Germany can best shield itself from
international turmoil by staying on its budget
consolidation course. FDP budget expert Otto Fricke told
Steinbrueck that he should have reduced the budget deficit
even further during the last two years, when strong growth
generated a revenue windfall of more than 9 billion euros.
All opposition speakers and some from the ruling parties
expressed their doubts about the government's ability to
reach a balanced budget by 2011. This view is shared by
several of Germany's leading economic research institutes.
The cooling of the economy will make it difficult for the

BERLIN 00001309 002 OF 002

government to retain the revenue level projected in the
budget, Thomas Straubhaar of the Hamburg based HBWI said.

Growing Election Time Appetite

6. The beginning of a national election campaign has
already wetted appetites for additional spending. The
Bavarian CSU - facing state elections on September 28 - was
the first party to demand additional tax reductions "to
allow citizens to participate in Germany's improved
economic situation." The grand coalition has also
announced that it will further reduce individual
contribution shares to the unemployment insurance fund from
the current 3.3% to 3.0% - or even lower. The government
is expected to approve a tax deduction increase for those
paying child support. Foreign Minister and Vice Chancellor
Steinmeier - the SPD's announced candidate for Chancellor
in 2009 - has called for more spending on education.
Finally, the commuter tax break is expected to be
reinstated (due to a probable court decision), which will
result in several billion euros worth of revenue losses for
the federal budget.


7. Increasing pressures on spending during an election year
coupled with the expected economic slowdown will make it
difficult to stay the course. So far Steinbrueck's strong
position within the SPD and the backing he receives from
Chancellor Merkel have prevented any deviation from the
government's budget consolidation course. Both are
determined -- probably even more so in times of financial
uncertainties -- to make budget consolidation one of the
shining accomplishments of the CDU-SPD Coalition. For the
German voter, such fiscal conservatism remains a virtue,
particularly in times of crisis.


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