France Snapshot December 2013
Fundamentals Update as at 12 December 2013 by Lorenzo Beriozza
After some improvement earlier this year, French business surveys are again bucking the (timid) euro area improvement trend. In the past it was easier to register more optimistic views than the consensus on France –and the data have supported this, in the sense that France has outperformed euro area GDP growth for the past three years, it must be stressed that, from a bond market perspective, France could hardly be associated with the “euro area periphery”. And, indeed, bond rates have remained contained and relatively close to the German Benchmark. France needs to push on with further structural reforms, though, notably on the labour market and competitiveness front. Some steps in the right direction have been taken, but more needs to be done.
Timing is of the essence. The risk of killing one of the few remaining engines of growth in the euro area – French domestic demand – is not a good idea, especially if there is no other strong engine to take up the baton of growth. As a consequence, France needs to build a solid reform framework, applying those reforms in earnest only once domestic demand in Germany takes off more robustly. This is, en passant, the strategy deployed by Germany in the 2000s: reforms happened while the rest of the euro area was enjoying strong domestic demand growth.
Overall, recent data are consistent with the view that French GDP will likely under-perform the euro area next year, after several years of outperformance. Political support has been weak(ening). The popularity of the government is currently very low. However, in the context of improving euro area growth numbers, the relative underperformance of the French economy should occur without causing too much additional collateral damage to the French government.
Still, only a more significant overhaul of the economy will lift potential growth in France. That will probably take time – despite some positive timid signs of change in the labour market and on labour costs. In the meantime, France will have to rely predominantly on stronger external demand and still supportive ECB policies.
While it may be likely that growth will pick up somewhat next year in France – GDP is expected to accelerate to just over 1% from just above flat this year, mainly thanks to a recovery in external demand from France’s key European trade partners and the US The view that French GDP in 2014 is likely to under-perform the euro area for the first time in several years remains sustained.
Domestic demand is likely to remain subdued in 2014, despite a less severe fiscal adjustment next year. The French government view that machinery & equipment investment is only likely to see a small increase next year (after a 2% fall in 2013), while the contribution from private consumption should be muted, unless more significant reduction in the (currently quite high) household saving ratio is incorporated in the forecast.
Indeed, recent investment surveys have not been particularly encouraging and the fundamentals for a major investment rebound appear rather weak. Despite some recovery in expected demand, and still favourable credit conditions, profit margins and capacity utilisation indicators remain underwhelming. Tax cuts for corporates, under the CICE Mechanism could help at the margin, but they are unlikely to be a game changer. To be fair, retail sales have shown some underlying strength in recent months – despite the headline weakness due to lower energy consumption (weather-related) – driven by durable goods in particular. Strength in the latter was, however, partly due to temporary factors affecting the auto sector that might, symmetrically, dent next year’s consumption prospects. The increase in the VAT is also potentially a drag on consumption, although the impact on 2014 inflation is expected to be rather limited.
Politically, the current administration is going through a difficult patch. Opinion polls are showing a record-low level of support for President Hollande and for his government. Meanwhile, the nationalist party (Front National) appears to have strengthened its position ahead of the local and European elections next year. This might affect only marginally the government for now, given the solid majority in Parliament of the current administration, but it could still complicate the life of the government, influence at the margin policies and reforms, and be an issue especially at the local level (elections are due in March 2014) and even more so at the European level, in the May 2014 elections.
Recent good news on the labour market front, even if helped by a boost from government aided jobs, could provide some needed support to public perceptions of the government. The European Commission (EC) concluded in its April report that France’s key problem was a progressive loss of competitiveness, with the high public debt also an issue – although one shared with most countries in the world.
The loss of competitiveness has taken place despite relatively contained unit labour costs putting the emphasis on non-price factors. Poor corporate profitability has had a negative impact on investment potential and thus on competitiveness. While a recent package (including the so-called CICE, aimed at lowering labour costs) provides some support to price and non-price competitiveness, this is as a key step in the right direction, rather than a game changer. Some encouraging signs are coming from the labour market reform, in particular in its practical application to the car sector in France – although it is still too early to make a thorough assessment of the overall impact of the recent labour market changes. Another needed structural reform is the overhaul of the tax system. France is known for its high tax burden, and in particular for high employers’ social contributions. The general intention is to rebalance the tax burden and the financing of social security, away from labour and more towards indirect and real estate taxation – a move already initiated to some extent by recent government decisions (i.e., the above mentioned CICE coupled with next year’s VAT increase). The government, confronted with a wave of tax protests, has re-launched the idea of a deeper overhaul in taxation in recent weeks, although it has been timid as far as details are concerned.
On the fiscal front, the latest (November) EC forecasts are slightly more conservative than the ones from the government, although the difference is of only a few tenths of a point – just above 4% this year, and 3.8% in 2014 – and are broadly in line with estimates of the consensus view. 3 All rights reserved © PuriCassar AG, 2013.
One source of concern is that tax revenues have been lower than expected this year. This might well continue into next year, with a larger contribution to GDP growth coming from net trade – and with the latter notoriously less “tax rich” that domestic demand. In addition, the suspension of the eco tax that was due to enter into force in January 2014 could also make it more difficult to reach next year’s deficit target. The EC also points out that its forecast factors in a slight shortfall relative to official estimates, “but it cannot be excluded that the outturn will be even worse”.
Overall, the European Commission concluded that France is compliant with European rules so far, but also that it has little room for manoeuvre left. Moreover, additional measures will probably have to be taken next year to comply with the 3% deficit target for 2015, agreed at the European level.
Source: Credit Suisse
