Germany Peers Into the Recession Abyss

The German economy shrank more than expected in the first quarter of 2003, Finance Minister Hans Eichel announced on Thursday, leaving the country dangerously close to recession if not already in one. Eichel also announced a massive tax shortfall -- with the government estimating an €8.7 billion ($10 billion) drop from the originally anticipated €458.5 billion tax receipts this year.

The Federal Statistical Office had expected to announce a so-called "red zero" -- meaning it had previously forecast that the economy would indeed shrink, but at a nearly imperceptible level. Instead, real gross domestic product fell 0.2 percent during the first quarter from the previous quarter.

Technical recession

In the in the fourth quarter of 2002, the economy had already shrunk slightly from the previous quarter. If the Statistical Office doesn't revise its figures, Germany could already be in a recession, which is defined by two successive quarters of reduced GDP.

The news Thursday shook many economists, who had projected slight growth for Germany based on strong production data in the first three months. The German Institute for Economic Research had projected 0.3 percent growth in the economy due to increased manufacturing production.

But the outlook for the coming months is gloomy. For one thing, economists fear that the strong euro could negatively affect German exports. Nonetheless, experts say the year end could possibly see a slow increase in growth -- but only if the world economy picks up and the meteoric rise of the euro exchange rate slows down.

Revenue shortfall

Furthermore, fiscal experts working under the overall control of the Finance Ministry declared a reduction in tax revenue of €126.4 billion ($145 billion) between 2003 and 2006.

Eichel announced a supplementary budget and said that Germany would once again fail to meet EU deficit criteria, which caps the public spending deficit at 3 percent of GDP. Should the economy remain weak, the current calculations for the supplementary budget may also be discarded, he said.

Despite signs to the contrary, however, the government has said it would hold on to the full-year growth projection of 0.75 percent it uses for its calculations -- far more optimistic than that of any economic research institute. Government speakers said Thursday they had no plans to revise the figure.

Head banker sends warning

Meanwhile, German Central Bank President Ernst Welteke (photo) warned the government against using a tax hike to fill the shortfall. Despite the huge budget deficit, this would be "counter-productive," Welteke said.

The same goes for the planned increase in the tobacco tax, Welteke told the Berliner Zeitung newspaper. The problem should be solved solely through strict government spending reductions, Welteke warned.

He also said Germany must meet the terms of the EU stability pact. Otherwise, he warned, the country could lose its credibility within Europe and the pact would become tootheless. Despite the strict warning, Welteke left fiscal leaders a small opening: Should the crisis deepen, an increased sales tax could be a possiblility, he said.

In addition, Welteke said a reform of the social security system is "absolutely necessary," noting that the reforms planned by Chancellor Gerhard Schröder through his Agenda 2010 "are a step in the right direction, but aren't nearly enough."