The coalition parties' campaigns have been aided by recent good news on the economy, writes DEREK SCALLYin Berlin

CHANCELLOR ANGELA Merkel’s re-election hopes in tomorrow’s general election hang on her plan for modest tax cuts to stimulate further economic growth.

After winning kudos for managing the economic crisis in a grand coalition with her centre-left Social Democrat (SPD) rivals, Dr Merkel is campaigning for a new centre-right administration headed by her Christian Democrats (CDU).

In office with the pro-business Free Democrats (FDP), the outgoing German leader has promised moderate tax cuts to boost spending and stimulate Europe’s largest economy. The FDP wants to go further, with a radical tax system overhaul and an end to multi-billion-euro subsidies. Crucially, neither party has put a date on their tax proposals.

The SPD has dismissed tax cuts as unrealistic in a time of spiralling debt. It has proposed to increase the top tax rate while cutting the entry-level rate. In addition, the party is promising to introduce a statutory minimum wage, attacked by Dr Merkel’s Christian Democrats (CDU) as a job-killer.

In their last weeks in office, the outgoing CDU-SPD grand coalition made much of modest signs of economic recovery. But neither party has prepared voters for what’s to come: drastic spending cuts, lengthening dole queues and an extra €100 billion in borrowing next year to keep afloat Europe’s largest economy.

“The normal German hasn’t seen very much of the crisis and the government has been able to keep it away from them until now,” said Des Kenny, an Irish businessman based in Mainz. “They’re going to have to borrow billions next year and that money will have to come from somewhere, either cutting social transfers or raising taxes. They can’t keep borrowing.”

For Germany’s two largest parties, their “accentuate-the-positive” election strategy has been aided by a series of economic bright spells in recent days. The Ifo index of business confidence reached its highest level since September of last year, six months after reaching a 26-year low.

Meanwhile, economic institutes are predicting growth of 1.4-1.6 per cent next year after an estimated 4.5 per cent contraction in 2009. But all of these forecasts – like the government proposals – have two huge “ifs”. The first is that government stimulus measures continue to work into 2010. The second, that the world economy picks up and boosts sales of German cars and machines.

“Regardless of what party wins, they will have such narrow financial means in which to operate that it will be difficult to implement any of their plans,” said Stefan Bielmeier, chief economist of Deutsche Bank in Frankfurt. “In addition, the risk is that recovery is not sustainable when stimulus packages expire.”

The first stimulus package to expire, earlier this month, was the popular car scrappage scheme. It offered a €2,500 discount off a new car purchase for anyone trading in their old, nine-years-or-older car.

The scheme to keep afloat the car market had the desired effect, sparking a run to dealerships and a 28 per cent rise in car sales in August 2009 compared to the same month a year earlier.

But the government’s €5 billion pot ran dry early in September. A report into the consequences is grim reading for an industry that is the cornerstone of the German economy. The report by Roland Berger Consulting predicts the loss of up to 90,000 jobs, a 20 per cent collapse in demand for cars and a 40 per cent rise in bankruptcy risk for car dealerships.

Coupled with falling demand worldwide, industry analysts predict disastrous sales in the coming months. Ferdinand Dudenhöffer from the Centre for Automotive Research predicts a fall of one million sales to around 2.7 million cars next year.

“It will be the largest downturn ever suffered by the German car industry,” he said.

Adding to the general industry misery is the uncertain future of Opel. Despite a last-minute rescue deal, just in time for the election, Opel insiders say a final deal has to come before the end of the year, when its liquidity runs out.

Germany’s second stimulus package – short-time working – has helped avoid mass lay-offs, until now.

Workers who are sent home one day a week have two thirds of their lost daily earnings reimbursed by the state. Today around 1.4 million workers are in short-time schemes – 19,000 at Siemens and 30,000 at ThyssenKrupp alone.

The scheme has been extended until 2010, slowing the rise in the jobless rate but draining the reserves of the state labour office.

The agency will come under further pressure next year, and will probably need a state cash injection, if, as the OECD forecasts, the jobless rate rises from 10 to over 12 per cent.

Rising unemployment fears will see a 0.5 per cent contraction in private consumption next year, according to the Institute for German Economy (IW) in Cologne.

And what happens when the stimulus packages dry up?

“From then on the economy will be even more dependent on its export market, and the world economy recovery,” said IW chief economist Dr Rolf Kroker.

On the final days of the campaign trail, Dr Merkel has painted a muted picture and has already begun to manage expectations of a possible second term.

“I am pleased with the positive signals, but the crisis is not over when we reach the bottom,” she said. “The crisis will be over when we are back where we were before the crisis.”