Merz wins support for surge in spending, proclaiming 'Germany is back'

By Andreas Rinke, Holger Hansen and Sarah Marsh

BERLIN (Reuters) -German Chancellor-in-waiting Friedrich Merz said on Friday he had secured the crucial backing of the Greens for a massive increase in state borrowing, clearing the way for the outgoing parliament to approve the historic deal next week.

Merz's conservatives and the Social Democrats, who are in negotiations to form a government after an election last month, had proposed a 500 billion euro ($544 billion) fund for infrastructure and sweeping changes to borrowing rules to bolster defence and revive growth in Europe's largest economy.

With the Greens, they now likely have the two thirds majority necessary to pass constitutional amendments that upend decades of German fiscal conservatism.

A vote on the proposals is scheduled for Tuesday.

Merz has justified the urgent need to push the package through the outgoing parliament with recent shifts in U.S. policy under President Donald Trump, warning that a hostile Russia and an unreliable U.S. could leave the continent exposed.

"It is a clear message to our partners... but also to the enemies of our freedom: We are capable of defending ourselves," Merz, whose conservatives won the election, told a news conference.

"Germany is back. Germany is making a significant contribution to the defence of freedom and peace in Europe," he added.

Merz's measures cleared another major hurdle on Friday, with the constitutional court throwing out complaints against them.

News of the deal lifted euro zone government bond yields, shares and the euro on expectation the borrowing plan would boost the wider European economy. Germany's benchmark DAX stock index was up 1.6%, while the mid- and small-cap indexes rose over 2.6% and 3.2% respectively. The euro rose 0.3% - taking its gains so far this month to nearly 5%.

WINNING OVER THE GREENS

Merz wants to secure the funds before a new parliament convenes on March 25, where they risk being blocked by an expanded contingent of far-right and far-left lawmakers.

The compromise reached with the Greens includes the allocation of 100 billion euros for the climate and economic transformation fund from the 500 billion euros earmarked for infrastructure.

All the money must be spent on new programs, not to plug holes in the budget, over a 12 year period, the Greens, SPD and conservatives agreed.

They also agreed on a broader definition of the defence spending to be exempt from the constitutional spending cap above 1% of economic output.

Spending on civil defence, IT security and "aid to states attacked in violation of international law" - a clear reference to Ukraine - will also count as defence spending, meaning in theory Germany can borrow unlimited sums to finance them.

The swiftness with which Merz has reached such a historic deal could augur well for more decisive leadership from Germany going forward, despite his lack of experience in government, some analysts say.

His critics though, including the Greens, accuse him of "voter fraud" for promising not to open the spending taps during the campaign only to announce a tectonic shift in fiscal policy just days after winning.

Merz cannot afford to many defectors on Tuesday as his conservatives, SPD and Greens are set to clear the two thirds majority needed to pass constitutional amendments with just 30 votes to spare.

DEBT BRAKE 'BURIED'

The reforms, if passed, would mark a major rollback of the so-called 'debt brake' imposed after the 2008 global financial crisis but since criticised by many as outdated and putting Germany into a fiscal straitjacket.

"With today’s plan, the debt brake might not be entirely dead but rather buried alive," said Carsten Brzeski, global head of macro at ING.

"The only limiting fiscal rule for the German government will be the (EU) Stability and Growth Pact. And we know from past experiences that these rules can be soft as butter if needed."

Eurointelligence think tank also said it would amount to a "de facto abolition" of the debt brake, noting this would be positive if accompanied by structural reforms to ensure the economic revival were long-lived.

The planned infrastructure fund alone could raise German economic output by an average of more than two percentage points per year over the next 10 years, the DIW economic institute said.

The package is a "major boost and a turning point in German fiscal policy," said Daniel Hartmann, chief economist at asset manager Bantleon. "It creates new growth impulses in Germany but also increases the risk of inflation.

($1 = 0.9191 euros)

(Reporting by Andreas Rinke, Holger Hansen and Sarah Marsh; Additional reporting by Markus Wacket, Thomas Escritt, Rachel More, Miranda Murray, Rene Wagner, Matthias Williams and Friedrike Heine; Writing by Sarah Marsh; Editing by Toby Chopra)