German Chancellor Gerhard Schroeder announced cuts to Germany's generous pension system on Sunday, pressing ahead with an ambitious welfare reform drive that he has threatened to quit over unless he gets his way.

The pension reforms, a key element in Schroeder's "Agenda 2010" programme to revive a stagnant economy, included freezing benefits and making pensioners carry the full cost of elderly care insurance themselves.

Schroeder acknowledged the reforms, designed to keep pension contribution rates under control and plug gaps in benefit funding, amounted to an effective cut in real benefit levels.

"But if we don't start to address the demographic challenges decisively and with determination it will be too late when we do face this extreme change in our society in the coming years," Schroeder, who heads a centre-left government, told reporters.

Germany, like other major European economies such as France and Italy, is struggling to adjust its jobless, health and pension systems to weak economic growth and ageing populations.

The reforms put Schroeder on a confrontation course with Germany's 20 million pensioners and the head of the VdK pensioners association, Walter Hirrlinger, said the government would feel their anger.

"They only have one means of resisting and that is at the ballot box," he told the Freie Presse newspaper.

ECONOMY RECOVERING?

Economists expect Europe's largest economy to stagnate this year and some forecast unemployment will hit a post-war high of five million next year, but financial markets have been encouraged by Schroeder's reform plans.

The DAX index of 30 blue chip stocks has risen around 60 percent since Schroeder first announced the measures in March. The economy has shown signs of recovery and markets have welcomed signs that Germany can implement real change.

Schroeder's government still faces big risks, however. On Friday, he survived a parliamentary vote on his welfare cuts but the opposition is demanding big changes that could still derail the reforms.

The Bundestag lower house backed cuts in jobless benefit, plans to bring forward 15.6 billion euros ($18.12 billion) of tax cuts to 2004 and an increase in tobacco duties that will add around 33 percent to the price of a packet of cigarettes.

In a bid to win over leftwingers in his Social Democrats, Schroeder softened the benefit cuts and threatened to quit if they robbed him of his slender nine-seat majority. The leftwingers view the measures as a betrayal of party principles.

Yet even after Friday's hard-won victory, most of the reforms are certain to be revised as they must get through the Bundesrat upper house where opposition parties have a majority, meaning two more months of uncertainty for Schroeder.

On the pensions front, only a small part of the package requires approval from the Bundesrat, meaning the plans should avoid the wrangling that faces the welfare and tax changes.

Schroeder said the pension changes would enable the government to keep contribution levels stable at the current 19.5 percent of gross salary and avoid adding to high non-wage labour costs seen as a major drag on job creation.

A proposal that the statutory retirement age should be lifted gradually to 67 from 65 has been put off to allow@time for consideration, but Schroeder said the government would try to raise the effective retirement age in the short term.

The reforms come as Germany is showing signs of emerging from its second recession in as many years, holding out the chance of the continent's once undisputed economic powerhouse shaking off its new reputation as the "sick man of Europe".

The DGB union federation criticised the changes, saying they punished pensioners for three years of sluggish economic growth.

But employers and economists welcomed the decision to keep contribution levels stable.

"Under no circumstances should the government increase contributions further," the head of the Ifo economics research institute, Hans-Werner Sinn, told the daily Der Tagesspiegel.

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