What's Next For France?

Includes: EWQ
by: Remy Raisner, CFA

As much as Greece and Spain are capturing the markets' attention, of significant importance for the Euro zone are the recent changes in France. In addition to being at the forefront of the European crisis as one of its largest economies, France has seen its debt downgraded and elected a new president in May.

Investors have no doubt been worried about the direction the Hexagon is taking. François Hollande, the leftist new president, is seen as anti-business and anti-rich. He has campaigned on raising the French state's revenues more than cutting spending. In particular, he proposed raising taxes to 75% for taxpayers earning over 1 million euros, and reducing the minimum retirement age back to 60 years from 62 for workers who started their careers young.

The good

It is no secret that Europe needs radical changes if it is to cure itself and if the Euro zone is to survive. As anti-business as Hollande may be, austerity, as demanded by Germany, might not prove a way out of the crisis for Europe. The Euro zone is under a growing tower of debt, and economic expansion is highly needed to improve European nations' balance sheets. The knee-jerk austerity reaction might just too well contract business activity and worsen the situation, what the U.S. seem to have embraced with their implementation of Keynesian policies in light of the 2008 financial crisis.

Granted, the German position might not change until the German cost of borrowing starts to rise significantly. However, whereas Hollande's predecessor Nicolas Sarkozy aligned with Angela Merkel in supporting austerity for deeply indebted nations, the new French president and his government represent added pressure on Germany to ease its stance. Jean-Marc Ayrault, a former professor of German and a Germanophile, might prove a smart pick for prime minister if his background enables him to more easily broker a deal with Merkel's government. While euro-bonds might be years away, a banking union can be hoped for, even if the French and their Eastern neighbors are still far from a common ground on an issue to the crisis.

Appeasing to investors could also be the fact that there are signs that Hollande might not follow up on his most radical campaign themes. While he has been evasive on how to honor his commitment to reduce the budget deficit to 3% next year, rumors have it that the Hollande government is already planning to shrink the number of government workers and therefore the government's payroll.

Amid concerns about the competitiveness of French businesses, and with his focus on growth, Hollande might eventually have no other alternative than to embrace structural reforms (in particular that of the labor market) and liberalize the Hexagon's economy. This would in turn modernize the French left and bring it closer to its European counterparts, insofar as they are more economically liberal.

The bad

Taxes will rise - and are already doing so - if not for the left in power, because of the European crisis. New taxes will appear. The French government has announced that it will tax dividends 3% for large companies.

French banks, the largest being Société Générale, BNP Paribas and Crédit Agricole, most likely will lose income to the increase in the tax on financial transactions currently being discussed. Given their balance sheets (which include 2.2 trillion euros in debt and exposure to Europe's weakest economies), they would greatly benefit from a banking union. They have already drastically cut dividends to conserve capital, and Greek exposure alone cost French banks 8 billion euros in 2011.

The ugly

Hollande campaigned on being a 'normal' president - the antipodes of his predecessor Sarkozy whose flashy style earned him the pejorative nickname of 'president bling-bling'. But he is today in anything but a 'normal' situation. On June 17th, Hollande's Socialist party won an absolute majority at the parliamentary elections. Hollande currently has more power than any president in France's Fifth Republic (established in 1958). His party now controls both houses of the legislature, every French region except one, most of France's departments, large cities and communes. So should he chose to, Hollande has the power to implement the policies he campaigned on, what adds to the nervousness investors have experienced for some time with regards to France's prospects. Credit rating agencies are watching, some of which have a negative outlook on France.

Nevertheless, the political changes in France might not turn out to be as bad as feared, if François Hollande does not implement his most leftist policies. His evasiveness on his turnaround strategy is considered by some as a sign he will not. In any case, such policies would see human and financial capital flee so much that any growth would be crippled, at a time when business and investor confidence is already dipping -and any president in any country would gladly spare himself any period of national economic hardship.

Even if there are hiccups in the short run, in the long-run the French economy might benefit from the Euro zone crisis if it forces long-awaited structural changes and liberalization to occur. If anything, the crisis has brought to light the unsustainability of the current model, and Hollande has the power to implement the measures that will unleash the favorable fundamentals France enjoys: a diversified economy with demographic growth and an educated population that is amongst the most creative in the world.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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