Chancellor Schroeder's reform and tax cut proposals are producing a wave of optimism for the economy...
Chancellor Schroeder's reform and tax cut proposals are producing a wave of optimism for the economy.
The IFO economic institute report, released last week, shows business confidence is improving as a result of the government's tax cut proposals. The economy has grown by less than 0.6% since the end of 2000.
John Hatherly, head of global analysis at M&G, says two quarters of economic contraction have brought the importance of reform to the government's attention.
'The chancellor leans heavily on economic advisers of German multinationals like Volkswagen and Siemens and is conscious of the problems businesses are facing,' he adds.
The reforms proposed by Schroeder are designed to tackle labour inflexibility and pensions. Although these are still potentially long-term drags on German growth, business confidence has been quick to react to the announcement.
Dirk Schumacher, analyst at Goldman Sachs, says: 'While most of the reform measures announced by the government will not have an impact for some time, they provide an important psychological signal that Germany is on the move. Businesses have responded positively to these reforms and the rise in confidence is a key ingredient for a pick-up in investment.'
The reforms also include bringing forward tax cuts of around E21bn by one year to 2004. This means cutting top rate income tax to 42% from 48.5% and lower rate income tax from 19.9% to 15%.
While the weakened economy will reduce the short-term impact of any tax cut, the effects will be felt in the longer term, according to Hatherly.
'A weak economy has fewer companies and low consumption, so cutting taxes does not have a significant effect,' he says.
Because of the time lag for improvements to filter through the economy, the budget deficit will get worse before it gets better. This will put pressure on the German government to control spending so it does not deviate too much from the EU monetary stability pact.
Schumacher says: 'Because of Germany's unwillingness to jettison the stability pact, the deficit will need to be financed largely by expenditure cuts and other revenue raising measures to prevent the budget deficit from rising further in 2004.'
However, Hatherly believes the proposed reforms will ultimately reduce the need for government expenditure. The ECB is also likely to tolerate greater flexibility on the pact to foster significant improvements to Germany's economic prospects, he says.
The increasing optimism on the German economy is also due to the low interest rate environment of the eurozone. The ECB's base rate is at a record low of 2% after the bank's latest easing of 50 basis points in June, its seventh cut since 2001.
Schumacher says recent reform proposals and the low interest rate environment is making it more conducive for businesses to spend. 'Germany's private sector has a tremendous capacity to spend,' he notes. 'The private sector is generating positive cashflow equivalent to 6% of GDP compared to zero just three years ago.'
Since the end of the market bubble in 2000, German companies have been restructuring. As a result, Hatherly says, survival rates have remained high.
Germany implementing reforms.
Business confidence on the rise.
Firms restructuring and remain strong.
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