The German budget is deeper in the red than ever before. Economists believe that the government in Berlin will have to borrow an extra 35 billion euros minimum this year to meet its expenditures. And the EU’s finance watchdogs in Brussels are threatening to impose a massive fine if Germany makes no progress in driving its deficit below the 3 percent threshold allowed under the EU stability pact.

The daunting numbers loom over the social democrats and conservative christian union parties as they enter negotiations to form a grand coalition government under chancellor-designate Angela Merkel. The designated minister of finance, social democrat Peer Steinbrück, already said that huge spending cuts, particularly in state subsidies and welfare programs, would be unavoidable.

"I believe we will be forced to abide by the EU’s three percent deficit limit by 2007 at the latest," he said. "And I’m convinced that we can only achieve that through a massive effort to save well over 10 billion euros."

The CDU/CSU says the number should be closer to 25 billion euros. An agreement must be hammered out primarily on cutting expenditure in the social security systems, which have come under strain due to high unemployment and an aging population.

Also chancellor Schröder’s labor market reform has turned out to be much more expensive than expected. A crunch issue in the coalition talks is also the wholesale reduction of state subsidies.

Promises broken

One of the main election campaign promises of the CDU had been a reduction in corporate tax. Now Angela Merkel admits that this won’t happen.

"There‘s no room for a net reduction in corporate tax because we will overshoot the deficit limit again this year as the budget shortfall is reaching 4 percent," she said. "Consolidating the national budget will be our priority which means that any cuts in state subsidies will be used for that an cannot be spent on tax reduction."

Merkel says that the coalition negotiations must also come up with strategies for increasing economic growth as the only way to create more jobs. The outlook, however, is grim, according to economic forecasts that were revised this week. Leading economists who had predicted a 1.2 percent growth for the German economy this year have corrected that to a mere 0,8 percent. And on Friday the outgoing Schröder government itself was again forced to revise its figures along similar lines – reducing the expectation from 1.5 percent to 1.2 percent for the coming year. Most German economists say that would be far too little and wouldn’t help the job market at all.