A new, presumably stable government will soon take charge in Germany, at a time when the Trump administration has been driving a deep wedge between the US and EU – ratcheting up tension both on trade and geo-political fronts. Friedrich Merz of the Centre-Right Christian Democrats-Christian Social Union combine, which won 28.4 per cent of the votes in elections held last weekend, is expected to team up with the deposed Social Democrats who won just 16.4 per cent of the vote to form the new government. A wobbly Social Democrats led coalition lasted just three years and lost amidst resentment over Germany’s economic downturn (two straight years of contraction in 2023 and 2024), inflation, inadequate wages and pensions and migrants from eastern Europe, West Asia and Africa competing for jobs and welfare. Merz does not have an easy task ahead.
The world’s third largest economy with a current account surplus of over 5 per cent of its GDP has turned restive as both its economy and polity are being transformed. Indeed, a cocktail of stagnation, inflation and migration has led to a rightward shift in European politics, driven by nationalism, protectionism and opposition to migrants. Unsurprisingly, Alternative for Germany (AfD) doubled its vote share to 20.8 per cent. Its politics resonates well with that of the Donald Trump-Elon Musk duo, who openly expressed support for AfD. Yet, the winning CDP-CSU combine, which too has won on an anti-migrant, conservative values plank has distanced itself from Trump. At the heart of the conflict is a deep crack in the decades-old economic and security partnership between the US and EU.
Trump’s decision to slap steep tariffs on steel, aluminium and his threat to do so on imported cars could further hurt Germany, which along with Canada is a major supplier of steel and aluminium to the US, besides cars. Germany’s trade surplus with the US, its largest trade partner with China a close second, was $84 billion in 2024 in bilateral trade of about $260 billion. Yet, for an economy where trade accounts for about 90 per cent of its GDP, Germany cannot enhance its vulnerabilities – which have become pronounced since the Ukraine war began in 2022, raising Germany’s energy costs and inflation, as Russian gas supplies had to be substituted by gas from the US and other sources. The new government has to figure out how to fix the economy. This includes relaxing the ‘deficit brake’ that constrains the government from offering incentives to boost innovation.
Germany is also under pressure go back to coal and nuclear energy in the wake of the gas supply fiasco. This may lead to the developed world turning its back on climate targets. Energy markets could be impacted. Be that as it may, Germany and India can explore wider trade and investment ties in times of churn. There is scope to lift bilateral trade from current levels of about $26 billion (a $7 billion surplus for Germany) and cumulative investment to above $14 billion.