Analysis-Merz's reforms have potential - eventually - to boost German growth

By Maria Martinez

BERLIN, July 2 (Reuters) - A late-night deal agreed by Chancellor Friedrich Merz's ruling coalition on a long-awaited package of reforms has the potential to give Germany's anaemic economy a shot in the arm if implemented fully and quickly, economists and business leaders said.

The measures to cut red tape, offer tax relief to working families, allow more flexible job contracts and boost investment in housing come on top of last week's proposals to add a capital element to the state pension and gradually push back the retirement age.

The latest moves come 15 months after a landmark agreement on a €500 billion special fund for infrastructure and plans to largely remove defence investment from borrowing caps, paving the way for a spending surge that has nonetheless taken longer to materialise than many had expected.

"If implemented, Germany can become a better place to invest and create jobs again," said Holger Schmieding, chief economist at Berenberg of the new package combining both left-leaning and pro-business elements. 

He estimated the reforms could almost double Germany's trend growth rate from a dismal 0.4% to 0.7% per year, offering a much needed boost to an economy that has struggled to gain momentum.

Deutsche Bank's CEO Christian Sewing called the package "a very successful opening move", adding: "This is exactly the momentum we need to make Germany fit for the future." 

The individual measures agreed in the package are expected to be passed by parliament by the end of the year. 

"Admittedly... it is not a package that will morph a stagnating economy into a booming economy overnight," said Carsten Brzeski, global head of macro at ING. 

Failure to deliver on economic pledges could deepen public frustration and feed perceptions of government ineffectiveness, creating fertile ground for the far-right AfD party, which tops national polls.

"The reform package shows that both coalition partners were willing to compromise," said Marion Muehlberger from Deutsche Bank Research. "The German government agreed on one of its biggest reform packages in decades."

TAX RELIEF FOR LOWER EARNERS

Once the engine of European growth, the continent's largest economy has stalled as competition from China and higher energy prices have challenged its export-driven foundations and the reform package aims at boosting competitiveness, economists said. 

The package includes €10 billion ($11 billion) in annual tax relief for lower-income earners, more flexible labour laws, changes to the pension system and cutting red tape. Merz said an average family will get tax relief of €600. 

That will be funded mainly by raising the top tax rate to 47% from 45% for the highest earners, defined as those with annual income of €280,000 or more. 

The package includes cuts to red tape, including faster approval procedures for infrastructure projects and the abolition of some reporting and documentation requirements.

"The planned measures to reduce bureaucracy, in particular, show great promise because they could give German businesses more leeway," said Commerzbank's senior economist Ralph Solveen, who like others added the caveat that it all depended on effective implementation. 

The long list of measures also includes an action plan against benefit fraud, a target to cut staffing in federal ministries by 8% through digitisation and an end to workers' ability to obtain permission for sick leave by phone.

The proposals were criticised by the services union Verdi, which said they exemplified a "culture of mistrust" against workers. 

Germany's Association of General Practitioners also said the requirement for workers to obtain written confirmation of illness would be "absolutely disastrous" for already overburdened medical practices.

Whether praised or criticised, these measures will take time to feed into the economy.

"The potential risk for the government is that they might not be around to fully harvest on what they have now announced because it's going to take a while," Brzeski said.

(Reporting by Maria Martinez; editing by Mark John and Toby Chopra)