German tax proposals could boost the euro

Germany looks set to shed its image as Europe's structural reform laggard with a tax plan that could push its corporate sector into mega-mergers and help invigorate the flagging euro.

Just weeks after being attacked for lacking commitment to the free market with its intervention to rescue builder Philipp Holzmann AG, the government has unveiled a proposal to scrap tax on the sale of domestic shareholdings by one company in another.

The implications are enormous. The move to scrap the tax of about 50 per cent on share disposals would prompt Germany's big banks to offload their huge corporate shareholdings profitably, thereby encouraging industrial tie-ups as well as bank mergers.

"This move will violently shake up corporate Germany," said Mr Thomas Mayer, senior economist at Goldman Sachs in Frankfurt.

"It shows that the desire to reform is there. At the end of the year the government is being viewed quite differently from its role in the Holzmann rescue. But the proof of the pudding is in the eating and we have yet to see this implemented."

The tax plan was mentioned in a footnote to broad tax reform proposals presented by the German government on December 21st, but markets only recognised its significance on December 23rd.

The German stock-market surged, sending the blue chip DAX index up more than 4 per cent to a new all-time high of 6,798.19 during the day. The euro also got a modest boost and was quoted at $1.0170 in late trade. Doubts about Germany's commitment to structural reform had helped push the currency to all-time lows against the dollar in recent weeks.

"This is too good to be true," said Mr Michael Kunz, banking analyst at Banque Nationale de Paris in Frankfurt.

However, analysts were quick to warn that the proposal is still a long way from becoming law, and that it may be watered down. Germany's banks are chronically undervalued on the stock market, partly because this tax has prevented them from unlocking hidden reserves and investing the money more profitably, and now face the prospect of a surge in market capitalisation, according to Mr Kunz.

Deutsche's unrealised reserves - the gain that would be realised if it sold its shareholdings - amounted to €38 per share, he explained. For Dresdner the gain would be €28.7 and for Commerzbank €3.3. If the market reflected Deutsche's and Dresdner's full hidden reserves, their share prices would rise by more than 30 per cent, he said.

Corporate Germany has long been marked by large bank stakes in industry, the legacy of close and long-lasting business ties between individual banks and companies. The system has allowed banks to determine the course of German industry through their representation on company supervisory boards.

But critics have long argued that the system gives banks too much power and prevents adequate supervision because bankers are stretched too thin through their representation on many different supervisory boards.

The Holzmann crisis was a case in point. Deutsche Bank holds 15 per cent of the troubled builder and chairs its supervisory board but was unable to detect billions of marks of losses which brought Holzmann to the brink of collapse.

Deutsche's huge shareholdings also include a 12 per cent stake in DaimlerChrysler AG, 7.0 per cent of insurer Allianz AG and 10 per centy of Munich Re. The bank welcomed the latest tax plan.

"If this proposal is implemented it is a move in the direction we have been calling for," a spokesman said.

"It will permit an active management of our shareholdings and will be very helpful for the German economy and its financial centre."

Analysts said the funds released by the sale of shareholdings would fill up the German banks' war chests, while gains in their market capitalisation would allow them to seek mergers through share swaps.

However, major obstacles remain to large scale domestic bank consolidation in Germany because public sector banks such as Westdeutsche Landesbank continue to dominate about half the market and are unlikely to start merging with their private counterparts, analysts said.