BERLIN (Reuters) - Chancellor Olaf Scholz on Tuesday sought to reassure the German people and businesses that his government would modernise the economy and support vital industries such as chip factories, despite a court ruling that tore a hole in the federal budget.
A constitutional court ruling nearly two weeks ago blocked the government's plans to reallocate unused pandemic funds towards green initiatives and industry support, raising fears Germany's economy could be further weakened.
The verdict also called into question Germany's traditionally strict fiscal policy and sparked warnings that companies could be starved of support to keep them globally competitive against subsidies offered elsewhere.
Speaking to parliament as he grapples with a crisis that has shaken his coalition government, Scholz referenced the COVID pandemic, the war in Ukraine and soaring energy prices.
"It would be a grave and unforgivable mistake to neglect the modernisation of our country in the face of all these acute challenges," Scholz told the Bundestag in a 25-minute speech.
The country's federal states had the greatest interest in securing investment in areas such as semiconductors, climate-friendly steel production and battery plants, he said, addressing concerns of specific industries who fear losing out.
Scholz said the government would end a scheme to cap energy prices by the end of this year, but promised to act quickly if prices shot up again.
However, he left open the question of whether the government would try to suspend Germany's constitutionally enshrined debt brakes again in 2024, which some in his coalition and union members called for but the opposition might challenge in court.
SPENDING CURBS AN OPTION
Scholz said his government was working with parliament to draw up a 2024 budget "as quickly as possible" that could include spending curbs.
Scholz's assurances that his government would solve the budget crisis with care were met with jeers and laughter from the opposition Christian Democrats (CDU), whose lawsuit against the government had sparked the earlier court ruling.
"I don't know how to interpret your laughing there," said Scholz, who in English invoked the song "You'll Never Walk Alone" to reassure Germans of the government's support through difficult times.
He underscored support for Ukraine, after the recent budget turmoil raised questions over how much military aid Berlin was willing to commit. Scholz's government has pledged to double support to 8 billion euros ($8.76 billion) next year.
"It is also clear that we must not let up in our support for Ukraine and in overcoming the energy crisis. That would not be responsible, that would endanger our future," he said.
Foreign Minister Annalena Baerbock later told a NATO meeting in Brussels that Germany would bring its defence spending up to the alliance's target of 2% of gross domestic product next year.
CDU leader Friedrich Merz accused Scholz's government of a brazen attempt to circumvent borrowing rules and said its behaviour risked undermining the European Union's wider fiscal reforms in upcoming negotiations.
"If the dams burst in Germany, they will also not hold in all other countries in the currency union," Merz said. "Germany has a function as a role model there and you need to realise that, whether you like it or not."
Germany had a debt-to-GDP ratio of 65% in 2022, compared with 117% for France, 148% for Italy and 116% for Spain, OECD data show.
Hendrik Wuest, CDU premier of the state of North Rhine-Westphalia, said the government had ruined Germany's reputation as an anchor of stability in just two years. "The international damage is huge," he told the Rheinische Post newspaper.
Memories of how frugality paved the way for postwar reconstruction and how costly it was to re-integrate indebted ex-communist East Germany have shaped a uniquely debt-averse political culture.
In order to keep supporting industry, Finance Minister Christian Lindner has ruled out tax rises and said savings would have to be found elsewhere, backed up by welfare reforms.
The popularity of Scholz's coalition has sagged during a period of weak economic performance, rising inflation and higher interest rates.
But offering some reprieve, a new survey by Forsa suggested only just over a third of Germans believe a CDU-led government could do a better job of solving the budget crisis than the ruling coalition, while 59% did not.
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(Reporting by Andreas Rinke, Christian Kraemer, Miranda Murray, Rachel More, Maria Martinez; Writing by Matthias Williams; editing by Kirsti Knolle, Bernadette Baum and Alex Richardson)