Sunday, 15 July 2018

Comment: Will France remain in Europe's core?

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France faces the frightening and humiliating, if narrow, chance that by the end of this year it may no longer qualify as a paid-up member of core Europe.

That’s the risk if, lulled by the apparent calming of the debt market waters and without anything approaching a strong national consensus about reform, France sails later this year into another bout of euro insecurity and finds its own debt out of favor and its ability to borrow compromised. 

With an April 22 first-round presidential vote fast approaching neither of the two likely survivors, incumbent Nicholas Sarkozy of the conservative UMP or Socialist front-runner Francois Hollande, have enunciated anything approaching a strong commitment to the sorts of labor market, retirement and fiscal reforms now being espoused, if not yet successfully pursued, by weaker euro partners such as Italy, Greece and Spain. 

That’s likely because those sorts of policies are terribly unpopular in France, which allocates the highest proportion of its economic output to government spending of any nation in the euro zone, and so anyone banging on about them ahead of the first round is unlikely to get a chance to take part in the run-off on May 6. 

We might assume that either leading candidate, if elected, will get on with the business of crafting a sustainable budget and a path towards higher French competitiveness. That might be right, but it is a big assumption, and needs to be balanced against the bald fact that the French do not seem to want this type of reform very badly, if at all, and may only really consent if forced by events. In this way, perhaps, the current lull in euro panic, courtesy of the ECB’s flood of lending, may be raising the risks for France, as it provides a supportive background for doing nothing or very little. 

“On our list of what could still go wrong in Europe this year, France holds the top spot,” Holger Schmieding, chief economist at Berenberg Bank wrote in a note to clients. 

“The issue for France is that its growth model relies on an overly active role of government and frequent stimuli to private consumption. That model is not sustainable in the long run.” 

Indeed, French government spending accounts for 54 percent of GDP, against a euro zone average of 48 percent. 


That’s not encouraging: they are at the back of the pack on that measure of a group that has already lurched from crisis to crisis. The fundamental weakness of the euro zone - that it has no true central bank which can and will act as a backstop for sovereign borrowers - is still true even through the central bank has papered over difficulties for now. 

Counterbalancing the reliance on public spending is a more modest deficit of about 5 percent of GDP, placing France slightly above the euro zone average and well below those of Britain and the United States. 

Again, Britain and the U.S., unlike France, have the luxury of their own currencies and the power of their own central banks, both of which have been busily engaging in spectacular measures to support their respective economies. It is simply a lot more lonely being France, protestations of solidarity among Europeans notwithstanding. 

“Two key questions for Europe are now how much of a crisis it may take until France grasps the nettle of reform, and whether such a crisis may come while Italy and Spain are still vulnerable (now) or already on the safe side (2013 or 2014?),” Schmieding writes. 

In a study Berenberg Bank carried out with think tank The Lisbon Council, France ranked 13th of 17 euro zone states in overall economic health, and just as worryingly came 15th in making progress towards economic adjustment. And France has a bit of catching up to do: whereas real unit labor costs in the euro zone fell between 2002 and 2010 they rose in France, undermining its competitiveness within Europe and globally. 

None of this is to say it is assured that France’s premier league status will be seriously challenged. It will, by force of will and political might, stay in the game even if an additional ratings agency besides Standard & Poor’s strips it of its AAA status. 

In the eyes of investors, however, there is much to be wary of: poor long-term trends, a lack of political will to arrest those trends and, perhaps most worryingly of all, reliance on a central bank with a track record of intervening late and without force. It is hard to see an ECB program like the current LTRO working if France is in trouble, and it is equally hard to see the ECB stepping up further if it did not. 

A run on French debt sometime this year is not out of the question.

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