Having survived the Kosovo war with his popularity intact, Chancellor Gerhard Schroeder declared today that he is ready to confront what could prove to be the most perilous challenge of his tenure--a drastic overhaul of Germany's elaborate and costly welfare system.

Schroeder said he will press ahead with the Herculean task of cutting social spending and modernizing the flagging German economy despite protests from fellow Social Democrats, scorn from political opponents and skepticism among leading economists. "We will go down this road, determined and not straying, because it is the right direction," Schroeder told reporters on the eve of the government's annual summer break. "We have to persevere because the future of our country is at stake."

During his first nine months in office, Schroeder managed to postpone hard economic choices as he fended off challenges from left-wing rivals, such as former finance minister and Social Democratic Party leader Oskar Lafontaine, and demands from his unruly partners in the coalition government, the environmentalist Greens.

When a frustrated Lafontaine quit politics in March, Schroeder seized control of the Social Democratic machinery and vowed to move the traditionally leftist party toward the center. Then came Kosovo and NATO's 11-week air war against Yugoslavia, which preoccupied Schroeder and Foreign Minister Joschka Fischer, the Greens leader, as they struggled to keep their coalition together.

But as many of Germany's 82 million people begin heading for beach or mountain vacations, Schroeder seems to recognize that a moment of truth has arrived that could make or break his grip on power. When the government has completed its move from Bonn to Berlin and parliament reopens for business in September, Schroeder warned, Germany will face an autumn of painful but necessary sacrifices to restore its eminence in the global economy.

In its latest study of international competitiveness, the World Economic Forum reported that Germany had slipped to 25th place, behind Chile and South Korea. Even though it remains one of the world's industrial powerhouses, Germany has the world's highest labor costs, with workers paid an average of nearly $30 an hour. The high wages, short workweeks and demanding labor rules have scared away foreign investors, which has hindered efforts to reduce an unemployment rate that is now running at 11 percent.

Despite the gravity of Germany's economic plight, Schroeder's austerity budget--which calls for $16 billion in spending cuts, mainly in pensions and other social benefits--has outraged much of the country. Farmers are complaining about shrinking subsidies, labor unions are angry about corporate tax relief, and many Social Democrats are upset about a reduction in allocations for eastern Germany.

While calling for a new show of party discipline, Schroeder said he relishes the prospect of a lively debate. But he insisted that Germany's enormous state debt, which quintupled under his Christian Democratic predecessor, Helmut Kohl, to nearly $1 trillion, must be curtailed. "We have shouldered the burdens that others have avoided," Schroeder said. "We never expected to be everybody's darlings."

Schroeder's austerity program already appears certain to exact a political price. Even though he and Fischer remain the country's most popular politicians, the favorable rating of the Social Democrats has dropped to 32 percent in the latest polls, while the Greens have fallen below the 5 percent level needed to qualify for representation in parliament. Support for the opposition Christian Democrats has grown to 45 percent, while that of the liberal Free Democrats stands at nearly 7 percent.

If those polls are reflected in regional elections this year, the opposition parties would secure a clear majority in the upper house of the federal Parliament, the Bundesrat, and be able to block Schroeder's legislation--much in the same way that the Social Democrats stymied Kohl's programs in his last years in office.

Beside trying to persuade the country to accept his austerity measures, Schroeder also faces a showdown with the Greens over how quickly the country should retire its 19 nuclear power stations--which provide about 35 percent of Germany's electricity. After listening to complaints from power companies that any phase-out schedule faster than 25 to 30 years would cripple the economy, Schroeder has urged the Greens to back off their demands for an accelerated timetable.

Even though Germany's "red-green" ruling alliance has been a rocky marriage, the close working relationship between Schroeder and Fischer--coupled with the desire of both parties to defy the disastrous forecasts of their political enemies--has kept them together. Even their most bitter opponent, Christian Democratic leader Wolfgang Schaeuble, predicted last week that the government would survive the four-year legislative term.

But for a party whose aversion to nuclear power is one of its founding principles, the notion of compromise on the issue has compelled some Greens to question the purpose of staying in government. After abandoning their pacifist leanings to support the air war in Kosovo, hundreds of Green activists have vowed to tear up their membership cards and bolt the party if it surrenders to Schroeder on the nuclear power issue.

CAPTION: Gerhard Schroeder vows to restore Germany's market competitiveness.