Germany's Merz sees signs economy turning corner, IMF says mid-term prospects constrained

By Maria Martinez

BERLIN (Reuters) -German Chancellor Friedrich Merz on Wednesday said there were signs the economy is turning a corner following his landmark reform of fiscal rules earlier this year, but the International Monetary Fund warned medium-term prospects remain constrained.

Germany is the only member of the G7 group of advanced economies that has failed to grow for the past two years, and only modest growth of 0.2% is expected this year, according to IMF forecasts published in a report on Wednesday.

"Although we are in the middle and not at the end of our agenda, although the geo-economic and geopolitical winds have recently become even rougher, there are nevertheless signs of a trend reversal," Merz said in a speech to the lower house of parliament, the Bundestag.

AGING POPULATION, SUBDUED PRODUCTIVITY

The IMF in its report said the increased expenditure was set to drive a gradual acceleration of domestic investment and consumption, and that real GDP growth was set to grow around 1.0% in 2026 and 1.5% in 2027.

But beyond that, rapid population aging and subdued productivity growth will start to kick in, it said.

"With a new government in place, now is the time to take decisive measures," Kevin Fletcher, an advisor in the European Department of the IMF, told a news conference.

There is a growing sense among economists, investors and business groups that the promised reforms are slower and less far-reaching than initially expected.

Responding to those criticisms, Merz in his speech promised to work "at a fast pace" on the needed reforms.

FISCAL SPACE MUST BE USED JUDICIOUSLY

The IMF said the fiscal space now available must be used judiciously to boost the economy's longer-term productive capacity and be complemented by pro-growth structural reforms.

Those could include measures to foster more innovation and digitalization, cut red tape, reduce labour supply constraints and deepen European economic integration, they said.

One of the most important things that Germany can do to boost growth is to take a lead in deepening the EU single market, Fletcher said, as this would improve productivity in Germany and also boost exports to the rest of Europe, which remains by far Germany's most important export market.

The deficit is projected to widen to about 4% of GDP by 2027 and debt is projected to rise to around 68% of GDP by 2027, still the lowest among the G7 economies, the IMF said.

(Reporting by Maria Martinez, Editing by Miranda Murray and Conor Humphries)