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German fears of economic impact of Ukraine crisis growing, but Merkel's support strong

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BERLIN - Ordinary Germans are spooked about the future. Businesses are starting to see black clouds on the horizon. And an economy that has been the envy of Europe is showing cracks, shrinking unexpectedly last quarter amid the conflict in Ukraine.

It might seem like enough to put any leader into trouble. But Chancellor Angela Merkel's popularity remains sky-high — with nobody in sight to touch her.

It shows the German public is prepared to endure some hardships — such as a rise in energy costs if the sanctions war with Russia escalates — as long as Merkel is seen as dealing strongly with the crisis.

"She holds her line, and this gives the German electorate the impression she is doing a good job in the interests of Germany," said Nils Diederich, a political scientist at Berlin's Free University. "I don't think that there are very many governments in Europe with such a stable position as the German government at this moment."

Merkel's support stands at 65 per cent according to the latest polls, and her party was also by far the most popular in Germany. While Merkel's measured approach has helped the perception that she is steering the country deftly through chaotic times, she also benefits from the fact that Germany is not in as vulnerable a position as others, especially Eastern European countries.

Germany is the largest single purchaser of Russian gas, but it only represents around 30 per cent of its overall gas supply. If Russian President Vladimir Putin stopped gas flows from Russia completely — something Merkel has noted didn't even happen at the height of the Cold War — Germany could increase supplies from elsewhere, albeit at greater cost. It could also ramp-up other sources of energy production, like coal-fired electrical plants, to take up much of the slack.

"The Russians need the German money," said Carsten Brzeski, chief economist at ING-DiBa bank in Frankfurt. "I would think that if Putin starts to retaliate on energy, he will go for Eastern European countries because they are sometimes as much as 100 per cent dependent on Russian gas.

"He would cause much more pain there than he would in Germany and he would lose less money."

In terms of trade, German exports to Russia were worth 36.1 billion euros last year — no small change, but only 3.3 per cent of the country's overall foreign trade. Imports from Russia were 40.4 billion euros, or 4.5 per cent of the total.

That places Russia as Germany's No. 11 trade partner, behind France, the Netherlands, China, the U.S., the U.K., and several other European countries. And Brzeski said sluggish growth among many of the more important trade partners represents a far greater threat to German exports than the Ukraine conflict does.

Still, while the second quarter 0.2 per cent contraction is seen largely as a temporary slowdown due primarily to a mild winter and other one-off factors, Merkel did caution this week that the Ukraine crisis remains an "uncertainty" for the economy. The Finance Ministry said the shrinkage was also "related to the effect of sanctions and negative effects on confidence due to the Ukraine crisis."

Germany's Committee on Eastern European Economic Relations, a joint organization of leading business associations, already estimates that in the first half of the year, sanctions and political tensions contributed to a 15.5 per cent decline in exports to Russia.

Early in the crisis, businesses had been largely against trade measures against Russia, but the powerful Federation of German Industry in July backed the possibility of more sanctions following the downing of Malaysian Airlines Flight 17 — saying that they may come at a painful cost, but should not be ruled out.

It seems now that businesses are willing to accept some damage to their bottom line to mitigate greater risks, Brzeski said.

He pointed to the GfK study released Tuesday, which reported that economic expectations among German consumers had "completely collapsed" over concerns about the conflicts in Iraq, Israel and Ukraine. At the same time, the Ifo institute's business climate study released Monday showed companies' expectations for the next six months down only slightly in August.

Businesses don't seem particularly worried right now, but that could change quickly if Ukraine fears prompt people to put off high-priced purchases — like a new Mercdes, BMW, Audi or Porsche — he said.

"Businesses see the risk of potential psychological spillovers," he said. "At first they screamed Russia is very important, but I think now the risk of a war in the area would have a bigger impact on sentiment than the real actual impact from sanctions and a trade war."

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