Germany's Economic Woes Tarnish Its Model Image

The country's problems are affecting its neighbors, threaten single-currency plan

WITH Germany in a recession, its role as a model economy for Europe ''has taken a bit of a bruising lately,'' says economist Michael Lewis of Deutsche Morgan Grenfell in London.

Germany's slowdown is having pronounced effects on its neighbors and has called into question whether the European Union will launch its common currency on time in 1999. France, the Benelux countries, and Austria, along with Germany itself, are having to trim their national budgets to meet strict ''convergence criteria'' for entry into the European monetary union (EMU). Such trimming would be much easier in a period of more robust growth.

But economists are cautiously hopeful that Germany will get its house in order so that the currency union starts on schedule: They anticipate an upturn in the business cycle starting in midyear, which will make fiscal adjustments easier. And perhaps more important, they see the political will to proceed with currency union.

Germany has long had a role as Europe's Musterknabe, the ''model boy'' other countries expect to demonstrate fiscal responsibility, says Commerzbank economist Pieter Pietsch in Frankfurt. ''Our politicians are very much conscious of this role-model function.... I'm convinced that we'll meet the target.''

He is referring to the EMU requirement that budget deficits be no more than 3 percent of gross domestic product - the nation's output of goods and services.

Germans had a rude shock at the turn of the year when it was announced that the expected 2.9 percent deficit for 1995 was actually 3.6 percent. This surprise got the Bonn government to refrain somewhat from lecturing its neighbors on fiscal restraint.

But, says Paul Horne, chief international economist at Smith Barney in Paris, ''they should have got last year right before they did.'' He suggests there was either ''some dissimulation or misreading of the data.''

The economy as a whole, moreover, was found to have contracted during the final quarter of 1995, and is widely expected to show further contraction for the first quarter of 1996. The causes: a surge in the value of the deutsche mark, which crimped German exports; the expensive labor contracts reached last year; and the slowdown in residential construction as a result of year-end changes in the tax code.

This is a recession, by the American standard; Germans prefer to call it a ''pause.''

By whatever name, it is clearly affecting Germany's neighbors. Rainer Veit, first vice president of DB Research GmbH in Frankfurt, notes that the French government has revised its economic growth forecast for 1996 downward from 2.25 percent to 1.3 percent. The situation is similar in the Benelux countries and Austria. ''It's not a question of Europe tumbling into deep recession,'' Mr. Veit says, but of prolonged stagnation.

An upturn is expected during the second half of the year - but these forecasts reflect a ''degree of wishful thinking,'' Mr. Horne says. Business and consumer confidence is still dropping in France and Germany - ''There's been no bottoming out of the pessimism.''

Some analysts expect Germany's central bank, the Bundesbank, to lower interest rates at a meeting of its policymakers March 28.

Even if the pace of the German economy picks up during the second half of the year, a budget deficit of around 3.5 percent is anticipated for 1996.

But Mr. Lewis says that Chancellor Helmut Kohl's government should be able to be ''more aggressive'' about cutting government spending, now that state elections on March 24 have confirmed the Free Democrats (Liberals) as a still-viable coalition partner for Mr. Kohl's own Christian Democrats. This has effectively silenced talk of a ''grand coalition'' government with the Social Democrats, who lost ground in the state elections.

Veit sees the budget gap as manageable: With some cuts in the social net, and some indirect taxes, ''it should be possible to reduce the deficit to close to 3 percent.'' The EMU criteria call for ''3 percent,'' not ''close to 3 percent,'' but Veit says, ''it will be a purely political decision to go ahead'' with the currency union.

Horne, of Smith Barney, concurs, comparing the EMU decision to the decision to exchange East and West German marks one for one at the time of reunification in 1990. The Bundesbank wanted to see Eastern currency discounted. But Kohl insisted otherwise. ''And I think that was a correct decision,'' Horne says.