Germany’s government collapse: Market impact

The collapse of Germany’s three-party coalition government has injected a fresh wave of political and economic uncertainty into the country. With several key decisions pending before new elections, businesses and investors alike are bracing for potential disruption.

The dissolution of Germany’s government stems from escalating tensions within Chancellor Olaf Scholz’s coalition of the Social Democrats (SPD), the Greens, and the Free Democrats (FDP). The breaking point came with Chancellor Scholz’s dismissal of Finance Minister Christian Lindner, the FDP leader, following prolonged disputes over fiscal policy. Central to these conflicts was disagreement over public investment and fiscal restraint, commonly referred to as the “debt brake.” Lindner’s removal triggered further turmoil, as two additional FDP ministers resigned, leaving the government without a majority.

Short-Term Priorities for Germany’s Government

In the aftermath, Scholz announced plans to lead a minority government in partnership with the Greens to sustain operations until new elections can be organized. A vote of confidence in the Bundestag is scheduled for December 16, 2024. If, as expected, the government fails to secure support, President Frank-Walter Steinmeier is likely to dissolve parliament, paving the way for new elections - potentially on February 23, 2025.

Despite the political deadlock, critical decisions must be made to sustain economic and social stability until a new government is in place. These include:

• Energy policy: Extending subsidies and price caps to shield industries and households.
• Military aid: Allocating funds for Ukraine support and NATO commitments.
• EU coordination: Aligning on trade, digital taxation, and funding mechanisms.

These interim measures will be closely watched by businesses and investors, who are keen to understand the impact on sectors reliant on government funding or regulatory stability.

A Fragmented Landscape

Germany’s upcoming elections are set to reveal a fragmented political landscape, with the conservative CDU, the populist BSW, and the partly far-right AfD expected to make gains. Forming a stable coalition may prove challenging, regardless of the victor.

Potential outcomes include a conservative coalition (CDU-led) that would likely emphasize fiscal restraint, deregulation, and lower taxes - prioritizing economic growth; or a left-leaning coalition (SPD-Green-Linke) that could push for higher public spending on welfare, infrastructure, and environmental projects, potentially raising corporate tax burdens.

Economic Implications

The immediate outlook remains clouded by uncertainty, with Germany projected to endure a second consecutive year of recession in 2024. The collapse of the government has dampened investor confidence, but new leadership could create opportunities for recovery in 2025.

Several key sectors stand to benefit from Germany’s shifting political and economic landscape, despite the current uncertainty. Infrastructure emerges as a clear priority, with cross-party agreement on the need to increase spending - ensuring continued investment irrespective of the election outcome. Defense spending is also set to grow, driven by escalating global tensions and Germany’s international commitments, which make this sector a critical focus for any future government. Energy, another pivotal area, remains at the forefront of policy discussions, with efforts to reduce costs and enhance infrastructure seen as essential. However, the Greens’ influence on energy policy may diminish if their role in the next government is reduced, potentially slowing progress on renewable energy initiatives.

From the perspective of private equity and M&A, the outcome of Germany’s elections could significantly shape the investment environment. A CDU-led government is widely viewed as more investor-friendly, favoring deregulation and fiscal policies aimed at stimulating growth. Friedrich Merz, the CDU leader and former Chairman of BlackRock Germany, is well-regarded by investors, reinforcing expectations of a supportive regulatory framework under his leadership.

For dealmakers, several themes stand out. Deregulation and tax stimulus measures are expected to drive investment activity, providing new opportunities for private equity. Infrastructure, defense, and energy are likely to emerge as the most promising sectors, given their alignment with anticipated policy priorities. Finally, a stabilized political environment post-election could help revive sentiment and catalyze a rebound in M&A activity in 2025, following a period of subdued market confidence.

This evolving landscape positions Germany as both a challenge and an opportunity for investors, with strategic sector choices and adaptability key to navigating the months ahead.

Businesses and investors will be watching closely as Europe’s largest economy navigates its way through this pivotal period.