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German rescue plan to restore confidence but challenge dynamics
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14:30, October 15, 2008

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Germany's 500 billion euro rescue plan for its financial market approved on Oct. 13 marks a strategic change in its policy coping with the financial crisis. The main purpose is to restore the market confidence. However, the prospect of a "strong government, weak banking sector" on the horizon may pose new challenges to dynamics of the western economies.

The plan, based on the consensus of the euro zone summit, offers 400 billion euro guarantee for inter-bank borrowings and 100 billion euro for "financial market stabilization fund" for recapitalization of banks and guarantee. It is the largest scale of financial rescue action in Germany since World War II.

As the two parties Christine Democratic Union and SPD have reached agreement, the scheme is expected to get nod from the legislators in Bundestag Bundesrat. The DAX soared by 11.4 percent to rebound to the 5000 points on Oct. 13 when the plan was declared. German economic and banking circles also warmly welcome the plan.

However, the government wants its money to be rewarding. The plan stipulates that banks have to pay 2 percent of the guarantee if they use it. The government predicts that not many banks will use it. But the measures will work in restoring the market confidence. What's more, if a bank chooses recapitalization, the government is entitled to buy as much as 33 percent of the equity of the bank with the "financial market stabilization fund" on one hand and restrict remuneration of the senior management of the bank on the other.

The German government experienced a change of mentality as the impact of the Wall Street financial crisis has been increasing in Germany. At the beginning of the crisis, only DAX listed Hypo Real Estate, the second largest mortgage lender in Germany was affected. The government, in collaboration with the banking sector, launched a 50 billion euro rescue plan for HRE to prevent further risk exposure of the whole banking sector and the stock market. Those efforts did not work.

The situation did not improved even after the significant interest rate cuts by major central banks in the world, including the European Central Bank. DAX lost 22 percent last week.

Mistrust between banks is thought to be the reason for that. There are reports about de facto suspension of inter-bank lending business. As banks also tightened its credit to enterprises, it will lead to growing bankruptcy and unemployment and shrinking tax revenues. The real economy will feel the pain soon.

The International Monetary Fund forecasted recently that Germany would see a zero economic growth next year.

Whether the 500 billion euro plan will bring a turning point needs to be observed.

By People's Daily Online

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