Germany's Scholz vows to modernise economy, back Ukraine, despite budget woes

By Andreas Rinke and Miranda Murray

BERLIN (Reuters) -German Chancellor Olaf Scholz on Tuesday sought to reassure the public and businesses that his government would modernise the economy and support vital industries such as chip factories, despite a court ruling that tore a hole in the federal budget.

A constitutional court ruling nearly two weeks ago blocked Berlin's plans to reallocate unused pandemic funds towards green initiatives and industry support, raising fears Germany's economy could be further weakened and shaking Scholz's coalition government.

The verdict also called into question Germany's traditionally strict fiscal policy and sparked warnings that companies could be starved of support to keep them globally competitive while subsidies were offered elsewhere.

Speaking to parliament, Scholz referenced the COVID pandemic, the war in Ukraine and soaring energy prices.

"It would be a grave and unforgivable mistake to neglect the modernisation of our country in the face of all these acute challenges," Scholz told the Bundestag in a 25-minute speech.

The country's federal states had the greatest interest in securing investment in areas such as semiconductors, climate-friendly steel production and battery plants, he said, addressing concerns of specific industries.

Scholz said the government would end a scheme to cap energy prices by the end of this year, but promised to act quickly if prices shot up again.

However, he left open the question of whether the government, which agreed to suspend Germany's constitutionally enshrined debt brake this year because of the crisis, would do it again in 2024, which some in his coalition and union members called for but the opposition might challenge in court.

SPENDING CURBS AN OPTION

Scholz said his government was working with parliament to draw up a 2024 budget "as quickly as possible" that could include spending curbs.

Scholz's assurances that his government would solve the budget crisis with care were met with jeers and laughter from the opposition Christian Democrats (CDU), whose lawsuit against the government had sparked the earlier court ruling.

He promised support for Ukraine would continue, after the recent budget turmoil raised questions over how much military aid Berlin was willing to commit. Scholz's government has pledged to double support for Kyiv to 8 billion euros ($8.76 billion) next year.

Foreign Minister Annalena Baerbock later told a NATO meeting in Brussels that Germany would bring its defence spending up to the alliance's target of 2% of gross domestic product next year.

'ROLE MODEL'

CDU leader Friedrich Merz accused Scholz's government of a brazen attempt to circumvent borrowing rules and said its behaviour risked undermining the European Union's wider fiscal reforms in upcoming negotiations.

"If the dams burst in Germany, they will also not hold in all other countries in the currency union," Merz said. "Germany has a function as a role model there."

Germany had a debt-to-GDP ratio of 65% in 2022, compared with 117% for France, 148% for Italy and 116% for Spain, OECD data show.

Hendrik Wuest, CDU premier of the state of North Rhine-Westphalia, said the government had ruined Germany's reputation as an anchor of stability in just two years. "The international damage is huge," he told the Rheinische Post newspaper.

Memories of how frugality paved the way for postwar reconstruction and how costly it was to re-integrate indebted ex-communist East Germany have shaped a uniquely debt-averse political culture.

In order to keep supporting industry, Finance Minister Christian Lindner has ruled out tax rises and said savings would have to be found elsewhere, backed up by potentially difficult welfare reforms.

"We had no room for manouevre even before the ruling," Christoph Landscheidt, head of the local government association in North Rhine-Westphalia, told the Rheinische Post. "We've never before had such a pile-up of crises, all placing massive demands on local government budgets."

Coalition party leaders are due to meet on Wednesday evening to thrash out a path to the 2024 budget. Their popularity has sagged during a period of weak economic performance, rising inflation and higher interest rates.

But offering some reprieve, a new survey by Forsa suggested only just over a third of Germans believe a CDU-led government could handle the budget crisis better than the ruling coalition, while 59% did not.

($1 = 0.9134 euros)

(Reporting by Andreas Rinke, Christian Kraemer, Miranda Murray, Rachel More, Maria Martinez, Alex Ratz; Writing by Matthias Williams and Thomas Escritt; editing by Kirsti Knolle, Bernadette Baum, Alex Richardson and Tomasz Janowski)