More importantly, this is not the government acting as a prosecutor and it's not an exercise in prosecutorial discretion (prosecutorial discretion is a concept

More importantly, this is not the government acting as a prosecutor and it's not an exercise in prosecutorial discretion (prosecutorial discretion is a concept that is largely alien to the German criminal justice system, anyway). The federal government gets a veto right here because it is an affected party – diplomatic relations are part of what §103 of the penal code aims to protect; there are other sections of the penal code that already deal with defamation – and to verify that reciprocity is observed. The federal government is neither equipped nor entitled to do the job of the actual prosecutors (which, except for certain types of offenses, is the responsibility of the states) and thus reasonably does not wish to preempt them.