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Germany is the largest economy in Europe. What if it shifts to the left?

Sunday’s election results are difficult to predict and the formation of a government could take weeks or months. But when the dust settles, polls suggest that the new Chancellor Olaf Scholz could be from the left-wing SPD, who as finance minister in a coalition with Merkel steered Germany’s economy through the pandemic. In the meantime, the Greens could more than double their seats in parliament. Scholz’s SPD and the Greens could work with the business-friendly Free Democratic Party and gain enough power to shift the country’s economic agenda to the left. Taxes and spending could rise if political leaders double digitization and climate policies, while caution about rising national debt could take a back seat.

“Greens and liberals in a coalition would bring in the freshest innovative forces that we have had in a German government for some time,” said Carsten Brzeski, Global Head of Macro Research at ING.

Global banks say that the final outcome of the tussle between the parties after the election is far from certain, while investors are advised to prepare for two possible outcomes: a coalition of the SPD, Greens and FDP or a narrow victory for Merkel’s center-right Christian Democrats Union under the leadership of Armin Laschet, who would probably also have to team up with the Greens and the FDP.

The first option would mark a step to the left, but it would be less dramatic than an alliance between the SPD, the Greens and the radical left Die Linke. This finding, which could prompt much more ambitious wealth redistribution and tax collection efforts, was downplayed by analysts and would likely surprise investors.

Whichever combination takes responsibility will have to deal with the ongoing recovery from the coronavirus pandemic. Germany’s economy is growing 2.9% this year and 4.6% next year after shrinking 4.9% in 2020, according to the latest forecasts from the Organization for Economic Cooperation and Development.

However, recent data suggests that momentum may ease. The Ifo index, which tracks the country’s business climate, fell for the third consecutive month in September, according to data released on Friday. Slower growth in China, tight supply chains and rising gas prices are likely to take their toll.

This withdrawal could put pressure on the country’s new heads of state and government to lift Germany’s famously tough budget rules so they can continue to spend on the domestic economy.

The country has introduced a so-called “debt brake” in the 2009 constitution, which with few exceptions severely restricted public borrowing after the financial crisis. Because of the pandemic, the debt rules have been suspended until 2023. This enabled German borrowing to skyrocket, with the country’s debt ratio climbing sharply to 70% in 2020.

Although such a ratio pales in comparison to the United States, where debt is now expected to exceed annual GDP, German central parties have sought to regain control of the country’s public finances. Meanwhile, the Greens want more permanent loosening of the debt rules.

UBS strategists Dean Turner and Maximilian Kunkel assume that the debt brake – which has become a core principle of German fiscal conservatism – will likely remain in place as it would require a two-thirds majority in parliament.

Still, they expect Germany’s new heads of state and government to find other ways to increase spending to tackle the climate crisis, an issue that has become even more important after the devastating floods in July.

“The only common area on which all parties agree is the need to address climate change,” Turner and Kunkel wrote in a recent research note. Whichever coalition emerges, they continued, green investment “will grow”.

Fight the climate crisis

Brzeski expects that the new government coalition, regardless of its composition, will create a special investment instrument to circumvent the debt brake so that money can flow into green initiatives.

However, with a more liberal coalition government, some schedules could be pushed up.

“[The Greens] would probably push for an acceleration of the green transition of the German economy as a prerequisite for entry into government, “Goldman Sachs said recently in a statement to its customers.

The Greens called for a 70% reduction in greenhouse gas emissions from 1990 levels by 2030, compared to the current government target of 65%. She also wants coal-fired power plants to close by the end of the year in this decade instead of until 2038, and that new cars will also be emission-free by then.

This could lead to a conflict with Germany’s most powerful company. In its latest strategy update Volkswagen (VLKAF) By 2030, 50% of sales are to be achieved with electric cars and increase to almost 100% in 2040.

How much the state should intervene could lead to tension between coalition members.

“The biggest controversy will be: How do you change people’s behavior?” Brzeski said. “Do this through incentives and education, or do it through you [increasing] Prices and costs? “

A left-wing government in Germany could also lead to a tax increase for the richest Germans, with the SPD proposing a new wealth tax for the super-rich.

The banks emphasize, however, that the course of the election is still largely unclear – and the more conservative CDU could still prevail and Germany stick to its current fiscal and economic course.

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