Will Greece Decide The German Elections? ...........................
Will Greece Decide The German Elections? If So, What's Next?
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People walk past an election campaign billboard featuring German Chancellor and Christian Democrat (CDU) Angela Merkel in Berlin, Germany. Merkel is scheduled to face off against her main rival, German Social Democrats (SPD) chancellor candidate Peer Steinbrueck, in the German elections scheduled for September 22. (Image credit: Getty Images via @daylife)
By Benn Steil & Dinah Walker
On September 22, Germans head to the polls for Europe’s most eagerly awaited elections – the elections that the rest of the world hopes will allow a freshly mandated Chancellor Angela Merkel to finally come to grips with Greece’s impending insolvency. Greece’s ability to secure continued financing is central to its ability to remain in the eurozone, which may in turn determine whether Portugal and others, some much larger and more important, can do so.
What is much less well known is that Greek solvency may itself be of great consequence to the German elections.
The International Monetary Fund has been making waves of late, not least in Germany, by casting doubt on Greece’s solvency – most recently, projecting a financing gap for Greece opening up in August of next year. IMF rules forbid Fund lending to countries with projected financing gaps over the coming twelve months.
The next IMF Greek program review, which will cover the issue of securing adequate funding for Greece through the end of 2014, is scheduled for September 29 – just one week after the German elections. The July review stated that additional financing will need to be identified by this time. Yet any delays in the formation of a new German government and wrangling over cabinet positions will make this impossible. Unfortunately, delays and wrangling are looking more and more likely.
Popular BPOP -1.63% support for Merkel’s CDU party has been invariant to shifts in Greek sentiment. Yet as the figure below shows, when the yield spread between German and Greek government bonds rises (and market optimism for Greek solvency falls), support for the CDU’s coalition partner, the small right-of-center, free-market FDP, falls. And support for the left-of-center SPD party rises.
Yields on 10-year Greek government bonds are up about 50 basis points over the past month. Market sentiment on Greece leading up to the German elections could have a real impact on the outcome. Greco-pessimism could dampen FDP prospects, possibly pushing the party out of the Bundestag entirely. The most recent polls show support for the FDP at around 5%, right at the threshold required for the party to enter the Bundestag.
The main party campaigns have avoided much discussion of international affairs. But the new euroskeptic Alternative for Germany (AfD) party appears to have gotten a boost in the polls from Finance Minister Wolfgang Schauble’s admission last month that Greece will need more aid. A recent Allensbach poll showed 8% of Germans “considering” voting for the AfD. If the AfD enters the Bundestag, the CDU (with sister CSU) and FDP may not control enough seats to form a coalition. Such a failure would mean an extended period of uncertainty as efforts are made to create a new one; in 2005, it took two months for a “grand coalition” CDU/CSU/SPD government to be put into place. Such a coalition, as well as a fresh round of elections, are real possibilities this time around.
Meanwhile, the long-awaited ruling of the German constitutional court on the legality of the eurozone’s “European Stability Mechanism” and the European Central Bank’s “Outright Monetary Transactions” lurks in the background, raising the specter of political limitations on Germany’s ability to fund eurozone crisis-relief initiatives. The prospect of German political paralysis could result in further spiking of Greek yield spreads, reviving the eurozone crisis at a time when the eurozone will be least able to deal with it.
In short, those expecting the German elections finally to allow the EU to sort out Greece, and end the eurozone crisis, may be sorely disappointed. They may instead mark the beginning of a new and more worrisome phase.
Benn Steil (Twitter: @BennSteil) is director of international economics at the Council on Foreign Relations and author The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order. Dinah Walker is an analyst at the Council.
