Angela Merkel will have to soften some of her radical economic reforms if the so-called grand coalition of left and right is to get Germany back to work, analysts said on Monday.
A work in progress: Analysts hope Germany's reforms will get a boost
A stable government of Social Democrat SPD and Christian Union CDU/CSU parties might be able to push through at least some of the key reforms needed to get the euro-zone's biggest economy back on its feet, they say.
And financial markets, which were initially wary about the prospect of a grand coalition, also appear to be coming round to the idea that a left-right administration might not be so bad as first appeared.
Amid market perceptions that the reform process, which experts say it crucial for economic growth, would come to a halt, both the German stock markets and the euro fell in the first days following the election.
But three weeks later, the blue-chip DAX 30 index is back at its highest level in around three and a half years and business confidence is on the rise.
As a result, economists are warming to the prospect of a new government which, while it might not necessarily agree on how to reform the labor market, may well be in a position to shake up the country's federal system, simplify the tax system and get its public finances in order.
"The hope that Germany would be a shining European example for accelerated reforms has been dashed," said Bank of America economist Holger Schmieding.
Onward with reforms
Nevertheless, Germany had already made significant progress in overhauling its economy and some of that process would still continue under a grand coalition.
Even Deutsche Bank chief economist Norbert Walter, who had gloomily proclaimed that Germany could be on the verge of a new recession if the reform process ground to a halt, said there was some common ground for a grand coalition.
"I'm thinking of the reform of the federal system, but there could also be a common denominator in some areas in pension provisions and labor market policy that could enable small reforms to be pushed through," Walter said.
A grand coalition, in which the economy ministry will be headed by Bavaria's conservative leader Edmund Stoiber, could indeed prove more stable than some of the other groupings mooted in recent weeks, such as a three-way alliance between Merkel's CDU, the pro-business liberal FDP and the environmentalist Green party, analysts said.
"Federalism reform can only happen in a grand coalition. Cleaning up the budget and simplifying the tax system are other areas that could be tackled," said the head of the Berlin-based economic research institute DIW, Klaus Zimmermann, recently.
Under the German parliamentary system, opposition parties tend to build a majority in the upper house, the Bundesrat, putting them in a position to block key government legislation.
With a grand coalition holding the majority in both the lower and upper parliamentary houses, such political stalemate, at least on matters of tax, budget and the federal system, can be avoided.
Sticky labor market issue
The one area that the two sides may not be able to agree on is labor market reforms.
Merkel had vowed to slash labor costs, ease rules on hiring and firing and allow companies to opt out of collective wage bargaining and tailor wage deals to their own particular economic situation.
The SPD, which shifted to the left in the election campaign in response to voters' anger at its own social reforms, is likely to resist such proposals.
Nevertheless, all in all, a government of both SPD and CDU may not be the major step backward that the markets had initially feared, and while the reform process may be slowed, it is unlikely to be abandoned altogether, analysts said.
Hans-Werner Sinn, head of the Munich-based economic think-tank Ifo, saw a number of advantages in a grand coalition, such as the consolidation of public spending.
But most of all, the CDU and SPD parties would jointly have more strength to prescribe "the necessary medicine" than they would individually, Sinn said. "A stable government is good for the economy," he said.
Another think tank, IW, said it expected the new government to continue a "moderate" course of reform that would pave the way for stronger growth next year.