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German federal elections: What to watch out for on election night

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BNP Paribas Asset Management
 

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This Sunday, 26 September, Germans are voting in parliamentary elections that mark the end of Angela Merkel’s 16 years in office. A new coalition government is coming, but its composition is far from certain.

Some 60.4 million electors over the age of 18 are eligible to vote. They will elect the lower house of the federal parliament, the Bundestag. Voting in person takes place on the day, although postal voting has already begun.

The polls will close at 18h on Sunday (17h UK time). Germany’s public TV stations will make their first projections of the election results shortly after. Official preliminary results are likely to be announced on Monday morning.

A new coalition is coming

One thing is already certain: Whichever party wins will have to put together a coalition to succeed the current government formed between the centre-right CDU and the centre-left SPD.

Coalition building is likely to take many weeks. There is normally a gap of 5-6 weeks between the election and the swearing-in of the new government. However, negotiations to form the current coalition government in 2017 took a record 172 days. This time round, the parties will be aware of the need for Germany to have a government by the end of the year to allow for an effective relationship with France, which takes over the rotating EU presidency on 1 January 2022.

Numerous possibilities

Only once before has federal Germany been ruled by a single party with a parliamentary majority. Coalitions are therefore the norm. Over the last 30 years, the secular decline of what were previously the major political parties (CDU/CSU and SPD) has ended the Lagerkampf, or ‘camp struggle’ between the heavyweights that dominated Germany’s post-war politics.

As the big parties declined, new ones emerged. Some of them, such as the hard-right Alternative for Germany (AfD), are considered by the other parties as unwelcome in any coalition. With the traditional political camps no longer able to win clear majorities, parties are forced to govern with others. (Germany’s 16 federal states number no less than 14 different varieties of coalition). There are numerous possibilities.

And a new Chancellor

The make-up of the next government only will be known once the winner is able to form an absolute majority in parliament with one or two other parties. So the next chancellor will not be known immediately.

Typically, the coalition party with the most seats picks the chancellor. But coalition building takes time as parties have to agree terms on key policies and haggle over ministerial appointments.

What to watch out for on election night

  • The relative performances of the centre-left SPD, the conservative CDU, the Greens and the free market FDP liberals
  • The possibility of another ‘grand coalition’ between SPD and CDU
  • Whether the socialist ‘Die Linke’ (the Left) party makes it into parliament (by winning at least 5% of the overall vote or securing at least three of the first-past-the-post constituency seats)
  • If an all-left coalition (SPD/die Linke/Greens) wins a majority.

It’s an open race

There may well be an upset on Sunday evening. A high turnout is predicted and there appear to be a large number of undecided voters – up to 40%, according to a recent poll.

Over the last week, the polls have stabilised, with the rise in support for the SPD appearing to have peaked and the CDU/CSU’s decline flattening out. Currently, the official government website shows the SPD with a small 2-6% lead, with the latest available polling average 25.2% for the SPD, 21.8% for CDU/CSU, 15.4% for the Greens, 11.2% for the Free Democrats, 11.2% for the far-right AfD, and 6.3% for the Left party.

Based on these polls, it would still seem that the most likely outcome is either a ‘traffic light’ coalition (SPD (red) – Greens – FDP (yellow)) or a ‘Jamaica’ coalition (CDU/CSU (black) – Greens – FDP (yellow)).

SPD versus CDU

Of particular importance will be the score of the SPD relative to the CDU. For ideological reasons, the free market FDP would certainly prefer a coalition with the centre-right CDU/CSU, but the margin of a SPD win would likely determine their options.

Were a slim SPD victory to weaken the claim of their leader Olaf Scholz to the chancellorship and strengthen that of CDU/CSU candidate Armin Laschet, it could cancel out the SPD’s advantage of having come first. A clear SPD victory could oblige the FDP to engage in discussions with Scholz.

Greens and FDP in a three-party coalition

The FDP’s performance relative to the Greens will help determine who can call the shots as a ‘kingmaker’ in a three-party coalition (it would be the first since the 1950’s).

In terms of building a coalition, the preferred third and senior partner would likely be the SPD for the Greens and CDU/CSU for the FDP.

Once in a coalition, the relative strength of the two junior members could also have policy implications on topics such as fiscal policy or Europe.

A left-wing coalition?

If the election result were to makes a ‘red (SPD) – green – red (Die Linke)’ coalition possible, it could affect the FDP’s strategy. The prospect of an all-left government could be an important bargaining chip for SDP and Greens to entice the FDP to enter into a traffic-light coalition with them, rather than a Jamaica coalition.

Views expressed so far suggest that both the SPD and the Greens would prefer to form a coalition with the FDP rather than the Left, which has some relatively radical views; however, a red–green–red cannot be completely excluded.

On the other hand, if the Die Linke party fails to win more than 5% of the overall vote (or secure at least three of the first-past-the-post constituency seats), it might not make it into parliament at all.

The absence of Die Linke representation would reduce the threshold for a majority for the other parties. In that case, a two-party majority becomes possible. Current polls suggest that such a weak showing for the Left is possible, but unlikely.

However, all else being equal, current polls suggest that in such a scenario, a coalition of SPD and Greens could become arithmetically feasible, while a CDU/CSU-FDP coalition might still not command a majority. SPD and Greens would then be expected to form a government quite swiftly and financial markets would probably anticipate laxer fiscal policy.

Another ‘grand’ coalition?

A coalition that includes both the SPD and CDU/CSU seems unlikely, but cannot be ruled out. Such a coalition would have to be at the expense of various permutations that have CDU/CSU and SPD at their core, such as a ‘Kenya’ coalition of CDU/CSU-Greens-SPD and a ‘Germany’ coalition of CDU/CDU-SPD-FDP.

Neither the SPD nor the CDU/CSU is likely to want to become junior partner to the other. In the event of an SPD win, it is possible that the CDU/CSU would prefer to enter into opposition rather than join a government under what was previously its junior partner.

Should the CDU/CSU win, the SPD may consider its decline in the polls during the Merkel era as a reason not to re-enter into a coalition with the CDU/CSU.

Longer-term investment implications

Probably the single most important issue with implications for German fiscal policy is the future of the ‘debt brake’ enshrined in the constitution. This limits annual federal government borrowing (adjusted for the economic cycle) to no more than 0.35% of GDP.

The CDU/CSU and the FDP are committed to maintaining the debt brake. Olaf Scholz, currently finance minister in Germany’s coalition government and SDP leader, has said he too would leave it in place. The Green Party, however, sees it as a hindrance, arguing that the rule should be circumvented to allow for greater investment.

For the moment, this debate is academic: the rule has been suspended until 2023 because of the economic damage caused by the COVID-19 pandemic. Soon it will have very real consequences, both for Germany and Europe.

The debt brake was written into the constitution in 2009. It included an even harsher limit on the federal states, which were supposed to run balanced budgets adjusted for the economic cycle from 2020 on (the pandemic forced them to invoke the ‘force majeure’ escape clause too). In 2011, the eurozone adopted a version in its fiscal rules.

The constraint on public spending was intended to avoid excessive outlays that left future generations to pay the bill. It was also supposed to bolster confidence in the government’s ability to repay its debts, lowering borrowing costs.

When the pandemic hit and the emergency clause was invoked – enabling one of the largest fiscal responses in the world, worth over 6% of GDP in 2020 – the debt brake was declared a success. Thrift, went the logic, had permitted the financing of the measures to counter the impact of COVID-19.

A missed opportunity to invest for the future?

An alternative analysis argues that the debt brake probably created more problems than it solved. Sustainable public finances are certainly important. However, for Germany, the debt brake may have imposed a limit that was tighter than necessary and prevented spending on renewing infrastructure and new technologies.

Germany arguably had room to borrow because what really matters is the relationship between growth of public debt. That is a function of new borrowing and interest rates, and of the economic growth supporting it.

During the pandemic, profound weaknesses were highlighted. These include a huge need for digitalisation, spending on the education system and infrastructure. Germany is also facing major challenges in reconciling the objective of carbon neutrality by 2045 without pulling the rug from under its export-led economy.

With interest rates below zero even before the pandemic, Germany had room to borrow more than 0.35% of GDP, even in good times, and invest to restructure its economy for the future. Instead, the debt brake meant that investment was squeezed, and between 2012 and 2017 was not high enough to stop the public capital stock from shrinking.

Therefore, the major question as we emerge from the pandemic is whether Germany could enter a new era of fiscal rules, including reform of the debt brake. At the moment, the debate is over how quickly the debt brake should be reinstated, and whether there should be provisions (the Greens favour off-balance sheet funding) allowing for investments to help Germany transform into a greener and more digitised economy.

If austerity were imposed, it would impede the economic recovery, with worrying implications for the eurozone economy. Further afield, the EU is due to review its fiscal rules soon. A German government rigidly applying domestic austerity policies is unlikely to behave differently elsewhere.

More broadly, this election will test the theory that the pandemic has led to a shift in the public mood with greater value now being placed on the state as a provider of public goods. There is a near consensus in Germany that the next government must do more to satisfy vast public spending needs.

Party manifestos of the SPD, the CDU/CSU, the Greens and the Left party identify railways, public transport, electric-vehicle charging stations, and internet infrastructure as among the targets for investments. Capital goods and technology hardware companies could benefit from the investment push.

The SPD, and the Greens, have put a figure of about EUR 50 billion on the additional financing needed annually, the CDU/CSU bloc and the pro-business FDP focus more on cutting red tape and creating  incentives for private investment.

A boost for the energy transition

There is broad support across Germany’s political parties for more investment amid public opinion backing for tougher climate policies. This should favour companies well positioned for the shift to a lower-carbon economy.

The election could provide a catalyst for energy transition companies as most of the coalitions would result in a government with a strong environmental mandate. All the major political parties have stated that they want to step up Germany’s climate ambitions based on the country achieving a challenging 65% CO2 reduction target for 2030.


Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.

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