Initial projections from Germany's Sunday elections have set the stage for prolonged coalition talks, potentially leading to months of policy uncertainty in Europe's largest economy and exacerbating its current stagnation.
The opposition conservatives emerged victorious, positioning Friedrich Merz as the likely next chancellor. Meanwhile, the far-right Alternative for Germany (AfD) achieved its best-ever result by finishing second in the exit polls.
The formation of a coalition government remains uncertain, with speculation whether Merz will need one or two additional parties to secure a working majority in the fragmented parliament.
Carsten Brzeski, global head of macro at ING, highlighted the complexity and potential setbacks in coalition discussions, which could dampen consumer and business confidence, underscoring the need for agreement on policies among coalition partners to attract foreign investments and improve Germany's economic outlook.
The German election campaign spotlighted the shift from being an economic powerhouse to a more nuanced approach, including uncertainties regarding the number of parties achieving the 5% threshold for parliamentary representation.
A potential two-party coalition led by Merz's CDU/CSU and SPD could materialize if the leftist BSW and the Free Democrats (FDP) fail to reach the threshold. However, a three-party coalition involving the ecologist Greens or the FDP would be necessary if they secure parliamentary seats, with challenges in budgeting and implementing major structural reforms.
Proposals for corporate tax cuts by the CDU and the Free Democrats aim to enhance Germany's competitiveness by aligning the corporate tax rate with the OECD average, potentially stimulating investment, GDP growth, and higher wages, as noted by Tax Foundation Europe.
While some debate surrounds the financing of proposed tax cuts and the revenue impact, the negotiations' outcome hinges on the coalition dynamics led by potential Chancellor Merz and the feasibility of reforming Germany's debt brake regulation.
In the scenario where the FDP plays a key role, modifying the constitutional debt brake could be more restricted. Despite challenges, prospects for pro-growth reforms remain contingent on balancing fiscal constraints and the imperative for economic revitalization.
The complex landscape of coalition politics poses hurdles for substantial reforms, such as debt brake modifications, given the stringent budgetary limitations and potential divisions among the main supporting parties – the CDU, SPD, and Greens.
In conclusion, further deliberations are needed to navigate the intricate path towards formulating a functional government capable of addressing pressing economic challenges and advancing reforms in Germany.
(1 euro = $1.05)