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Eurozone under pressure

Apr 26 2012 07:36 Reuters

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Berlin - A European backlash against austerity could force Germany to adjust its savings-first approach to the debt crisis, although political tumult and economic decline will still test the ability of eurozone leaders to hold their currency bloc together.

The strong performance of Socialist Francois Hollande in the first round of the French presidential election and the Dutch government's collapse in a row over budget cuts this week highlight the risks of a rebellion against Berlin's hardline emphasis on cutting deficits.

Should Hollande beat incumbent Nicolas Sarkozy in a runoff on May 6 and Chancellor Angela Merkel's conservatives lose an important regional election a week later, pressure will rise on the German leader to explore more growth-friendly policies.

However, the options for achieving growth in recession-mired southern European economies such as Greece are extremely limited, people close to the German leader concede.

By pushing up French and Dutch bond yields this week, financial markets have made clear they will punish countries that stray from the consolidation course, leaving Europe little choice but to grind it out and hope the bloc's increasingly brittle policy consensus holds.

"No one in Europe has the money for big stimulus programmes, no one can afford higher deficits," Peter Altmaier, parliamentary whip for Merkel's Christian Democrats (CDU), told reporters on Tuesday.

"And therefore growth must be achieved via other means like structural reforms. This is recognised across Europe."

That does not mean Berlin can avoid making some concessions to political forces across Europe who want a shift in strategy.

Huge dynamic

Merkel's main political rivals at home, the centre-left Social Democrats (SPD), are threatening to deny her the two-thirds majority in parliament she needs to pass the EU's "fiscal compact", a charter that would set tough budget rules in stone.

Like Hollande, the SPD wants a growth component added to the pact, and the party is in a strong position to scupper Merkel's plan to ram it through the Bundestag lower house next month.

Victory in an election in the big German state of North Rhine-Westphalia on May 13 could embolden the SPD to take a more confrontational approach with Merkel.

Among the party's demands are a financial markets tax to fund investment in the eurozone's reeling periphery, more flexible use of European Union structural funds, so-called project bonds and more lending power for the European Investment Bank.

Ulrike Guerot, who runs the Berlin office of the European Council on Foreign Relations, believes that if Hollande defeats Sarkozy next month and bands together with the SPD, they could force Merkel to adjust her austerity-first approach.

"If Hollande can get the choreography right, if he can get a large group of countries behind him and not turn this into an open confrontation with Merkel, I could imagine a huge dynamic for pro-growth policies," she said.

Signs that economic gloom elsewhere in Europe is hitting Germany could also affect Berlin's approach to the crisis.

With Chinese Premier Wen Jiabao visiting a trade fair in Hanover this week, the focus has been on the German economy's increasing reliance on China.

But exports to China make up only 7% of Germany's annual total, compared with 40% to the eurozone, leaving it highly dependent on the health of its neighbours - particularly France and the Netherlands.

"You could see economic weakness in other parts of the eurozone begin to drag on Germany," Peter Bofinger, a member of the German government's "wise men" council of economic advisers, told Reuters. "It's foolish to pretend that Germany is immune to what happens elsewhere in Europe."

Trade data have already pointed to a slowdown in German exports to its eurozone partners. A survey of purchasing managers on Monday showed the German manufacturing sector shrinking at its fastest pace in nearly three years, partly because of weak sales to southern Europe.

Merkel, who faces a federal election next year, is unlikely to give up her trump card - the robust German economy - without a fight.

Greece, Ireland, Netherlands

Still, the lack of workable options for boosting growth in Europe means the currency bloc is in for a rocky ride.

Perhaps the biggest political hurdle is an election in Greece on the same day France holds its runoff.

Opinion polls suggest the parties behind the current technocrat-led government in Athens - the conservative New Democracy and socialist PASOK - could win enough seats to form a government. However, coalition talks are likely to be long and difficult regardless of the result.

Fringe parties that have benefited from growing anger with the government's austerity-for-aid policies could also deliver a surprise, calling into question Greek support for the cuts mandated under its bailouts.

In Ireland, a referendum on the budget discipline pact scheduled for May 31 could inject more political uncertainty into crisis resolution efforts. And a strong showing by eurosceptic Freedom Party leader Geert Wilders in a snap Dutch election would be a major risk for the bloc.

Notwithstanding recent agreements to boost the financial firepower of Europe's rescue funds and the International Monetary Fund, political turmoil could eat away at investors' confidence, increasing risks to big eurozone economies such as Spain and Italy and rekindling breakup fears. 

eurozone  |  europe debt crisis  |  euro
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