By Stephen Sandelius
PARIS (MNI) – With the Eurozone debt crisis at its heels and
general elections only months away, France is losing the trust of its
creditors. Borrowing costs are rising and the country’s triple-A rating
looks increasing at risk.
The spread of French 10-year yields vs bunds rose 21 basis points
Monday to a high of 171 bps when the ratings agency Moody’s warned that
“elevated borrowing costs persisting for an extended period would
amplify the fiscal challenges the French government faces amid a
deteriorating growth outlook, with negative credit implications.”
“The deterioration in debt metrics and the potential for further
liabilities to emerge are exerting pressure on France’s creditworthiness
and the stable outlook (though not at this stage the level) of the
government’s Aaa debt rating,” Moody’s said, preparing clients in
advance for an eventual downgrade.
Some observers, like economist Jacques Attali, say the prime credit
rating has already been lost, de facto. Patrick Artus, chief economist
at Natixis, estimated Saturday that France was down to A+.
An official downgrade by one or more agency could oblige investment
funds to reduce their exposure to French debt further. This would also
jeopardize the precious triple-A rating of the European Financial
Stability Facility, the fund designed to ring-fence the debt crisis,
Eurogroup Chairman Jean-Claude Juncker warned Monday. He argued that a
rating shift by Moody’s on France’s debt would not be appropriate.
“Among the triple-A countries in Europe, France is the most
fragile,” said BNP Paribas economist Dominique Barbet.
The intensification of the debt crisis is creating a vicious cycle:
France’s guarantees to the EFSF look increasingly risky, as do French
banks’ exposure to Italian and Spanish debt.
There is also concern that France will overshoot its pubic deficit
targets — despite the government’s verbal assurances and its latest
austerity measures — since the budget assumption of 1.0% GDP growth
next year looks too rosy in the eyes of most economists.
Barbet, who expects only 0.3% GDP growth next year, estimated that
E5-6 billion in additional austerity measures would offer enough cushion
to compensate for disappointing activity, but he was “sceptical” that a
third austerity plan in as many months would reverse the spread
widening.
While the E17.4 billion in additional fiscal tightening announced
earlier this month by Prime Minister Francois Fillon was welcomed by
economists as a reasonable balance between spending cuts and revenue
hikes, it was largely ignored by the markets despite the implied savings
of nearly E65 billion through 2016, when the budget would be brought
into balance.
As spreads are trending only in one direction, even positive events
with little follow-through can “be a pretext to accelerate the
movement,” Barbet quipped.
Moreover, Fillon’s center-right government, which has pledged to
hit deficit targets at any cost, has a remaining shelf-life of only six
months. Though the popularity of President Nicolas Sarkozy has recovered
of late, he still faces a tough uphill battle for re-election.
Sarkozy’s most likely rival in presidential elections next spring
is Socialist Party candidate Francois Hollande who, like the government,
has committed to reducing the public deficit below the Maastricht
ceiling of 3% of GDP within a year of his election.
Yet Hollande is on the right wing of a party that opposed last
year’s pension reform, which is projected to trim the deficit by half a
point over time. Hollande himself has proposed adding 60,000 civil
servants to the country’s education payrolls, essentially unraveling a
key austerity measure of the government in power.
If the Socialists win next May, they may well have to govern in
coalition with the Greens, for whom deficit targets are anything but a
top priority. Reducing the budget shortfall must come through an
overhaul of the country’s economic growth model and not via austerity
measures, party leader Cecile Duflot said Sunday.
Even if international investors can stomach the idea that the next
president of France could be a “socialist”, they might well wonder
whether Hollande will be able to resist pressure from within his own
camp to water down the current austerity strategy. He has already given
himself an extra year to balance the budget.
Markets are now demanding an “uncertainty” premium on French debt,
observed Natixis economist Jean-Francois Robin: “I think the uncertainty
for France is essentially linked to the fact that nobody knows what will
happen after May.” He added: “This is putting pressure on Hollande to
demonstrate his budget credibility.”
Were the Socialists to reverse course and sign on to Sarkozy’s
initiative to anchor the balanced budget objective in the constitution,
it could reenforce a scenario of fiscal continuity after the elections,
Robin said, though he conceded that this alone would be “no silver
bullet.”
Ideally, the two leading political parties would commit to similar
budget strategies or at least conduct a “consensual campaign” on the
issue in order to reassure the markets, he ventured.
However, given the fallout from the current and planned social
spending cuts and the deep-rooted resentment in parts of the electorate
toward policies imposed by the EU or the ECB, there is a risk that
disgruntled voters faced with an austerity-austerity alternative from
the mainstream parties would turn to right- and left-wing extremists
who denounce such policies.
Even if French spreads narrow somewhat at the start of next year to
a range of 100-150 bps, they are likely to widen again as the election
approaches, Robin predicted. In this case, Moody’s may well follow the
market’s direction and put France on “negative watch” until after the
ballot or even until September, he said.
Moody’s itself acknowledged that “important risk factors for the
government’s balance sheet” — the outlook for economic growth and the
European debt crisis — “are outside the full control of the
government.”
For Barbet, the only lasting solution for French spreads and the
containment of the debt crisis would be a commitment on the part of the
European Central Bank to assume the role of lender of last resort for
Eurozone governments.
While the political consensus for this solution appears to be
gelling at a glacial pace, if at all, the economist did not rule out an
accord before the French ballot: “The elections appear very, very far
away in light of the pace of deterioration in the Eurozone.”
–Paris newsroom +331 4271 5540; email: ssandelius@marketnews.com
[TOPICS: M$X$$$,M$F$$$,M$$CR$,MFX$$$,MGX$$$,MT$$$$]
