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Summary

  • France's Hollande signals more time is needed to bring deficit down.
  • The government needs to present detailed spending cut plans to the EC.
  • Large pools of capital continue to treat French bonds simply like higher yielding bunds.

French President Hollande, fresh from a stunning defeat in local elections, is signaling that he will once seek the EC (and Germany's) forbearance to relax the fiscal rules yet again for the euro zone's second largest economy.

Yesterday INSEE reported that France's 2013 budget deficit was 4.3% of GDP. This over shot even the revised targets. A year ago, France committed to a 3.7% 2103 deficit. In September, it had been re-set to 4.1%. Last summer, the EC gave France an extra two years (2015) to bring its deficit to the mandated 3% of GDP.

France is likely to overshoot this year's 3.6% target. In the press conference following the election results, Hollande seems to lay the groundwork for what he will tell the EC in mid-April. He is to provide details of the 50 bln euro in spending cuts, in 2015-2017 and a 10 bln euro in the payroll tax. All told, Hollande plans to cut 30 bln euros charges for French businesses. As is well appreciated, the French government spends the equivalent of 57.1 % GDP, which is among the highest in the world. Revenue from income taxes is just less than 46% of GDP.

Hollande will ask for more time. He said, "There can be no question of undermining growth that is just returning." He wants his new prime minister Manuel Valls, from the pro-business wing of the Socialists, to convince Europe that France's "contribution to competitiveness and growth" is more important than the fiscal commitments.

Vall's appointment itself is part of the Hollande's peace offering. Valls is a fiscal conservative, if that label means anything in the context of French politics. He advocates enshrining the 3% deficit target into the constitution. In previous campaigns, Valls had advocated state support for small businesses, the end of the 35 hour work week and an increase in the minimum retirement age. To solidify the pro-business thrust, the controversial industry minister Monteborg may be dismissed.

Despite the rhetoric about having to act to head off advances by the National Front, Hollande's biggest threat comes from the revival of the center-right UMP. Le Pen's National Front did do well in the municipal elections, in the context of its own history, but it drew only 7% of the popular vote (and that is with a relatively low turnout) and won 12 municipalities. The UMP won 572 municipalities with populations in excess of 10,000. The Socialists won 349. Moreover, the National Front lost two cities that it had led in the first round (Avignon and Perpignan) and lost Forbach, where the party's number two (Florian Phillpport) ran.

The rebound in France's PMI is in fact encouraging. The manufacturing index had been below the 50-boom/bust level since July 2011, and today's report confirmed the recovery to 52.1 (51.9 in the flash reading and 49.7 in February). However, last week the government reported a new high in unemployment. The EC's 1% GDP forecast this year is still at risk. French banks' forecasts are generally below this, with some expecting half of this pace.

One could not tell from the performance of French bonds that they are nothing but somewhat higher yielding German bunds. The premium France pays over Germany stands near 53 bp on 10-year bonds. This is 10 bp less than at the start of the year. France pays about eight bp more than Germany on 2-year paper. Large pools of capital, like reserve managers and insurance companies, who appear to be among the more significant holders of French debt, seem to believe that when push-comes-to-shove, France will be kept in the core.

Ironically, the buying of French bonds by these large pools of capital have eased the pressure on the successive French governments from truly reforming. German had the fall of the Berlin Wall to provide, after a time, impetus for reform. Many peripheral countries have been forced by the financial crisis (and Germany and EC) to reform. France had the luxury of neither. The relatively low bond yields (and a CDS that is below 50 bp) gives French officials little sense of urgency.

Source: France Seeks Forbearance