By Stephen Sandelius
PARIS (MNI) – After two rating downgrades this year and more
looming, France appears to be testing investors’ good faith as it gropes
its way toward reforms to reduce deficits and overcome structural
handicaps.
“For now, France still has the benefit of the doubt,” said Rene
Defossez, fixed-income analyst at Natixis. “Next year will be a turning
point.”
“There is a huge risk of more tensions on France’s debt…if we do
not give clear signs that we are committed to improving
competitiveness,” Defossez warned.
Standard & Poors nudged France out of the top triple-A credit
bracket in January, and Moody’s followed suit earlier this month,
leaving only Fitch’s AAA in the balance. All three agencies have a
negative outlook.
Yet these downgrades have had virtually no lasting impact on
France’s borrowing costs. The 10-year yield at this month’s bond auction
was only marginally above September’s record low of 2.21%. The
government expects to save E2.4 billion on the debt service charges it
budgeted this year, financing more debt than last year at virtually the
same cost.
“Investors are still looking at what rating agencies say,” Defossez
said. “But if you want a serious view of sovereign risks, you need other
information.”
One could also argue that these historically low borrowing rates
have more to do with the spillover of safe-haven flows pouring into
Germany, where investors get barely 1.5% at the 10-year horizon.
Shifting to France offers a pick-up of over 50 basis points for a large,
liquid debt pool with limited additional risk in the short term.
The Socialist government under President Francois Hollande has no
doubt benefited from the track record of its predecessor, which managed
to undershoot its deficit targets the last three years. This year’s
target of 4.5% of GDP also appears within reach, if EU budget
authorities do not include the latest public aid to Dexia bank.
However, nearly everyone outside of government expects next year’s
deficit target of 3.0% to be overshot, since such unprecedented fiscal
tightening in a single year risks throttling economic activity, making
even the modest 0.8% GDP growth scenario look like wishful thinking.
Wary of the potential costs of a shift in the mood of creditors,
Finance Minister Pierre Moscovici reiterates whenever possible the
commitment to the 3% target, although some within the government and
many outside warn of risks. Even the IMF and OECD, traditionally ardent
defenders of rigorous public finances, now urge caution.
“It’s okay if France misses its targets due to cyclical
developments” – provided there is “a clear direction toward lower
structural deficits down the road,” said OECD expert Herve Boulhol.
While the markets would like “both high growth and low deficits,” the
focus is slowly shifting in favor of policies that assure more solid,
sustainable growth over the longer term, he explained.
“Probably more important in the current juncture, the government
has to show its determination to implement deep structural reforms,” he
said. “The competitiveness pact sent a positive signal.”
The OECD expects only 0.3% French GDP growth next year and sees the
nominal deficit overshooting the target by 0.4 point, and a 0.7-point
overshoot in 2014. Nevertheless, 10-year bond yields would remain on
average at this year’s low of 2.6% and creep up only half a point in
2014 – the same rise predicted for Germany.
“The current situation of low financing rates for France is not a
given; it’s conditional on policy action,” Boulhol cautioned, noting
that the OECD’s scenario also assumes a gradual improvement in the
Eurozone economy, from which France would benefit.
To its credit, the Socialist government has committed to a number
of measures aimed at boosting competitiveness, including a hefty E20
billion business tax rebate, which it hopes will spur innovation and
productive investment. It also intends to overhaul labor laws in order
to create more flexibility for employers while ensuring more security
for employees.
“France needs ambitious reforms,” Boulhol insisted, citing in
particular lingering rigidities in the labor market that protect those
with steady work at the expense of those, often new entrants, who
scramble from one temporary job to another. France must “profoundly
change the way the labor market operates,” Boulhol said. “Depending on
the depth of forthcoming reforms, investors might react.”
“It seems we are at a crossroads in many ways,” he added, warning
that “the worst outcome would be to have very shallow reforms and then
to claim important steps have been taken and ultimately lower confidence
in policy action.”
Defossez underscored the need for reforms to stimulate the labor
market, but also to improve the business environment with supply-side
measures to enhance competitiveness, stem the exodus of industry and
reduce the chronic trade deficit – in short “a kind of revolution that
will be difficult to implement.”
“France is probably the last country to take measures to try to
improve its competitiveness,” he said. “I think the government will
probably succeed to some extent, but it is difficult to say today
whether it will be enough.”
Defossez criticized the delay in implementation of the business tax
rebate until 2014, and he lamented the fact that employers and unions
are being told to come up with an accord on labor market reforms before
the government takes action.
Analysts at Goldman Sachs argue that the absence of market pressure
has so far allowed France to put off labor market adjustments: “More
intense external pressure appears to be necessary for the required steps
in this direction to be taken. But neither financial market tensions nor
unemployment and growth developments are likely to reach levels critical
enough to force such a change ahead of 2014. We therefore think it will
be some time before France’s structural adjustment gathers pace.”
If there is no major economic setback early next year, investors
could still accord France “a benefit of doubt” through the first half,
capping the risk premium on French over German bonds at around 80 basis
points, Defossez estimated.
In the past, Socialist governments have proven their ability to
implement key financial and structural reforms and may more easily reach
a deal with unions on the labor market, he said.
However, “if we don’t deliver what investors expect,” the rate
spread to Germany could test 100 basis points in the second half, and
“why not” the level of 150 basis points seen before this spring’s
elections, Defossez asked rhetorically. “The government knows all this,
of course.”
Still, there is little risk that France could face the much higher
borrowing costs now seen in Italy and Spain, which have lower credit
standings, the Natixis analyst stressed. “France still has a very good
rating,” and the risk investors take in buying French bonds remains
“very, very low,” he said.
If needed, the government could readily boost revenues to pay its
debts through adjustments in the tax system – for example, by closing
tax shelters which cost billions in returns, he said.
–Paris newsroom +331 4271 5540; email: ssandelius@marketnews.com
[TOPICS: M$F$$$,MT$$$$,MGX$$$,M$$FI$,M$X$$$,M$$CR$]
