Hollande provides unlikely impetus to crucial French reforms

France’s fate is inextricably linked to that of Europe as a whole. With the eurozone enjoying a period of stability and new president, François Hollande, pressing ahead with reforms, the outlook for the French economy looks markedly better than it did 12 months ago. Solomon Teague reports.

  • 25 Feb 2013
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While nobody is prepared to call the end of the European debt crisis just yet, there is no doubt the continent experienced a turning point in September 2012.

When ECB president Mario Draghi assured markets he would do whatever it took to save the euro and eurozone sovereign debt, including potentially unlimited purchases of bonds, his words had a profound impact on the continent as a whole, and the outlooks for all the eurozone states individually too.

"The European debt crisis has changed dimensions now," says Michala Marcussen, global head of economics at Société Générale. The issue of where sovereigns — and the banks to which they have become so interdependent — would get emergency funding if needed, was essentially resolved in the summer of 2012, when the ECB pledged to buy unlimited one to three year paper, she says. While funding is now solved, solvency requires growth, adds Marcussen.

The ECB’s move stabilised markets but its promises are contingent on beneficiary countries sticking to the conditions laid out in the European Stability Mechanism, namely austerity and structural reform. More than ever before, stability in France, and elsewhere in Europe, is dependent on the country being seen to deliver on austerity and structural reform.

In one sense the resolution has only changed the complexion of the problem, not solved it entirely. France’s challenge now is principally political as it weighs up the need for sweeping structural reform against the difficulty the socialist president will have in selling such measures to his electorate.

France can at least be grateful it has its election behind it, and will not now elect a leader that rejects reform, as Italy may do at the end of February. However, such is the integration of European states, and their problems, that such events in Italy could themselves trigger a fresh round of panic that could spill across borders into France and elsewhere.

Vote left, get right

There is some irony in the fact that it looks as though it will be a socialist who finally delivers the structural reform that his right wing predecessors have for so long failed to deliver. France needs to cut red tape and simplify regulations, which make it very expensive to form companies, and introduce considerably more flexibility into the labour market.

In France there is insufficient dialogue between the unions and the owners, says Jean-Paul Betbeze, chief economist at Crédit Agricole in Paris. All attempts at reform — of pensions, the labour market or anything else — are therefore far harder than necessary. This is in sharp contrast to Germany, at least partly accounting for the relatively greater appeal of Bunds versus French government bonds.

The National Pact for Growth, Competitiveness and Employment, unveiled on November 5 last year by prime minister Jean-Marc Ayrault, is a step in the right direction. A measure designed to increase competitiveness in France, its headline clause is a tax credit spread over three years, thereby cutting production costs.

The pact was announced just one day after Louis Gallois, the former chief executive of aerospace group EADS and corporate troubleshooter, published his government-commissioned report on competitiveness, in which he wrote of an "emergency situation" and called for a "competitiveness shock". The report’s 22 proposals included cutting the social contributions paid by employers by €20bn as well as those paid by employees by €10bn.

On the same day the International Monetary Fund weighed in with its own report, urging France to act or risk falling further behind its European peers, employing measures such as loosening employment laws to make it easier to both hire and fire workers, as well as cut payroll taxes to encourage employers to hire more staff.

However, arguably more significant is the agreement on labour market reform reached in January, giving employers greater freedom to cut salaries and wages, in return for greater protection of jobs. "The recent agreement signed in Paris between the unions and the owners is a very big change in this respect," says Betbeze. "Let us hope it will open a new social relationship in the country."

However, in exchange unions are calling for increased costs for the use of temporary workers, which looks like a step in the wrong direction. And it will be hard for a socialist president to resist such union demands.

But François Hollande appears to understand the nature of the country’s problems. After a nervy start to his presidency, the markets have settled, clearly believing he has shelved his socialist rhetoric and will chart a pragmatic course forward. And while some see his ill-fated 75% top rate of tax, or his reduction of the retirement age policies as indicative of his left wing leanings, others see clever manoeuvres to win the political capital needed to push through his other reforms.

His aggressive tax policies play well with his support base, politically, and will have less of a detrimental impact in France than they would in the US or UK. There are fewer ultra-rich individuals in France, and wages are more moderate. "The level of inequality is stable in France, unlike in the US where it is growing rapidly," says Betbeze. "The resentment caused by massive banker bonuses is an American story, not a French one."

With the approval of the mid-year corrective budget last year aimed at meeting the 4.5% deficit target in 2012, and a 2013 budget that is designed to achieve the 3.0% deficit target this year, the government has shown the seriousness of its commitment to fiscal discipline, says Olivier Bizimana, an economist at Morgan Stanley.

"The government seems to be moving faster on reform implementation than we, and most observers, were expecting," he adds. While these steps are quite small in the context of the overall changes required, he has still won admiration for sidelining the more extreme elements of his party.

Resisting change

The big question now is how the French electorate will respond to contentious reforms, particularly of pensions and the labour market. Some will doubt Hollande’s appetite or ability to push through sufficiently far-reaching reforms, particularly on pensions, lifting the retirement age as others in Europe have begun to do, and securing a sufficient increase in contributions to ensure plans are fully funded. If presidents from the right wing did not have the stomach for it, the logic goes, what hope is there for a socialist to stay the course? On labour market reform, too, there is recognition that he has made some progress, but economists argue more is needed to put France on a similar footing to Germany.

Yet many are surprisingly optimistic France will eventually get there, even if it is more likely to do so via a series of small, seemingly insufficient steps, with its slight progress on labour market reform providing the model.

In fact, says Michel Martinez, chief France economist at SG, this will be the first time in 30-40 years that the two sides have reached any agreement at all, and as such it could set a useful precedent on which further advances can be built. "This does not get us to where Germany or Denmark are overnight, but it is a step and the first step is always the hardest," he says. "It is a small step economically but a huge step politically."

If France’s challenge is now more political than economic, perhaps investors in French debt are right to be sanguine. Economically it has time on its side, and while sooner is always better than later, to some extent it makes little difference whether the reforms come this year or next, as long as it increases its long term growth potential.

"Yes, growth is likely to disappoint, but this shouldn’t be a big problem," says Marcussen. "Several aspects separate France from some of the peripherals that have found themselves in trouble. It does not have to worry about unruly regions or its ability to pass budgets, it has no problem collecting taxes, unlike somewhere like Greece where tax evasion is a really major problem. Moreover, France did not suffer a housing bust."

With a small manufacturing sector, France has seen a greater level of economic stability, says Dominique Barbet, BNP Paribas economist for France, with services tending to be more resilient during periods of recession. France also benefits from its large public sector, which tends to be slower to cut jobs than the private sector, meaning unemployment has been slower to rise. And unlike Italy and Spain, where wages are decreasing, in France wages are stable — at least before tax.

Like Italy, France sees moderate net negative international investment flows of -20%, but when you compare that to Spain’s -90%, France’s moderate reliance on international investors does not look much of a problem.

Factors well beyond France’s control also seem to be easing. China’s slowdown appears to be moderate, while indicators in the US suggest it could bounce back this year.

While GDP growth is clearly disappointing, hovering around the zero mark, unemployment looks resilient and shows no sign of spiking as it has in the periphery.

Despite these positives, many investors and market observers maintain a negative view on France, believing its deteriorating economic fundamentals eclipse those of its neighbours. The key economic measures — structural unemployment, external balance, performance of the industrial sector, tax burden, public debt — have reached a critical point of deterioration, says Bizimana, in large part as a result of the financial crisis. "The government cannot afford to delay structural economic reforms," he adds.

Under siege

The feeling is widespread enough that both French sovereign debt, and the country’s banks, have been targeted by short sellers throughout the crisis. Traders were betting there would be no money left after saving Italy and Spain, and that contagion would ensure the crisis spread north into France. So far, this has not proved to be the case.

No doubt, French banks must learn to adapt to a new macroeconomic reality. Traditionally very large banks, they have been profitable despite low margins, with Crédit Agricole generating around €5bn of pre-provision income on €2tr of assets over the last 12 months.

By contrast, BBVA, the Spanish bank, generated €4.5bn (7%) of net revenues and €2.4bn (3.8%) of operating income from €63.4bn of assets in South America (ex-Mexico), and €6.4bn (2.1%) of net revenues and €3.6bn (1.2%) of operating profits on €310bn of assets in Spain and Portugal.

As French banks’ balance sheets shrink, with borrowers remaining more cautious than before the crisis, more profit will need to be generated from smaller revenues.

At 5%, non-performing loans are low in France, relative to the more troubled economies of Europe, like Spain (11%) and Italy (17%), although they are higher than Germany. For the large banks they are lower still, though the figures will rise across the board if unemployment rises. Finally, bond markets are a third of corporate credit, versus only 5%-10% in the periphery.

French banks are coping well with the extra burdens brought about by Basel III regulations. On the capital side, French banks are well capitalised, with around three or four times more capital than they had pre-crisis, well above required levels. The liquidity requirements were more problematic, but have been modified and now look more feasible, says Betbeze.

France also escaped a housing market crash, unlike some of its European neighbours, which stands its economy — and its banks — in good stead. France remains a country with a shortage of housing, and steady, natural population growth, ensuring demand remains healthy. Houses tend not to be viewed as wealth assets in France, but places to live.

Having experienced heavy losses following a housing bubble in the 1980s, France did not see big home equity lending, as in the US, and mortgage lending was quite conservative, even before the crisis. With a prevalence of fixed rate mortgages, French households have not come under the same kind of pressure that threatens banks with a spike in NPLs.

Credit conditions in France have held up well compared with some of its neighbours. Loan costs in France are still affordable and comparable to those in Germany, even as the cost of loans in Spain and Italy have soared. This has made life considerably easier for SMEs in France than their peers across either of its borders to the south.

Credit supply has held up well, while demand is also firm, though naturally it has declined as borrowers wait for growth to pick up before further indebting themselves, says Marcussen. "We are not seeing a credit crunch in France, we are seeing reduced demand, but nothing like what we see in the periphery," he says.

Good access

Access to capital is very good, even by long term historic standards, for the larger corporates. As elsewhere in Europe, they have started to rely less on the bank market, and drift to the debt capital markets, where demand is outstripping supply.

Many are also diversifying into the US dollar market, giving them another, potentially cheaper option. Some are even looking further afield at renminbi issues, while maturities are being lengthened. In all, French bond issuance levels in 2012 were close to 2009 levels, making it one of the busiest years in French corporate DCM history.

French corporate bonds have seen a spike in liquidity as both equity and sovereign bond investors have come into the market. The private placement market has also swollen in response to investor demand for assets, with €3.5bn raised in the euro market via PPs in 2012. It is the smaller SMEs that are struggling to find capital, a picture that is repeated across Europe.

With a dearth of other attractive looking assets in the market, and some banks buying back their debt in the market, further limiting supply, there are plenty of yield-hungry investors happy to lend to the French government and banks.

"Investors who are short France are right on one level, but this is a story that will take three years to play out," says Alberto Gallo, head of European macro credit research at RBS. "We have taken the opposite view and have been long French banks since last year. If you look at the specifics, France looks very different from the periphery."

While French banks are very large at over 400%, of GDP, they have been swift to act in the deleveraging process and committed to their strategies to navigate the crisis. Crédit Agricole, for example, has been scaling back its activities in Greece, selling Emporiki, its Greek subsidiary, to Alpha Bank last year for €1.

Crédit Agricole had already provided funding to the subsidiary, to the tune of €2.1bn by the end of September 2012, demonstrating its eagerness to retreat following its six-year foray into Greece. But "the recapitalisation of Emporiki and subscription for the convertible bonds to be issued by Alpha Bank [as part of the terms of the deal] will immediately reduce this funding by approximately €0.7bn," Crédit Agricole said in a statement announcing the sale.

And while it took a big loss on the sale, its share price jumped 5% on the announcement, illustrating investor relief it would be able to focus on core businesses from now on.


Goldilocks debt

  Not too expensive and not too risky, but just right: why investors have been flocking to French sovereign bonds.   France is still considered a stable, core European state, as evidenced by its success in recent bond issues. French sovereign debt have been stable at around 60bp-65bp over Germany, demonstrating investors still have confidence, for whatever reason, in France’s ability to navigate the financial storm. French CDS spreads have tightened by around 150bp since the summer of 2012.

Several factors explain the historically low French interest rates and resulting lower spreads against German interest rates versus peripheral credits in recent months.

The general mood of economic uncertainty has reinforced investors’ desire for high quality credits with good liquidity, but also the desire for yield, says Philippe Mills, until recently CEO at Agence France Trésor in Paris. This particularly benefits the core issuers at the expense of peripherals.

The impact on France has been particularly beneficial, says Mills, reflecting investor confidence in the government commitment to deficit reduction. In addition, "the low rates environment set by ECB has pushed short term government securities rates close to zero or even in negative territory, leading investors to extend the duration of their investments to longer maturities in a search for yield," explains Mills. Historically low rates, and thus spreads, are not confined to France, but are also evident in the other strongest eurozone states, including Germany, Austria, Finland and Benelux.

With the available stock of double and triple-A assets dwindling all the time, France remains part of an exclusive club, ensuring its debt remains in demand. "We may well see further downgrades in the coming months, but we can be confident France will not drop below double-A in the foreseeable future," says Dominique Barbet, BNP Paribas economist for France.

In some ways French debt has emerged as the most desirable paper to hold. With German Bunds offering precious little return, investors seeking safe assets but higher returns have turned to French bonds, judging the additional yield to be greater than the additional risk.

French debt has also displayed considerably less volatility than either peripheral debt or Bunds, says Barbet. "In a world of uncertainty, it is attractive to have part of your portfolio in something that is pretty stable," he says.

Despite a lot of speculation about France being dragged into full blown crisis, in fact it has always looked a very strong credit, says Michel Martinez, chief France economist at SG. "The usual triggers for crisis were just not present in France." In particular the French banking sector looks sound, while unemployment, though high, has not spiked to dangerous levels.

In terms of sovereign debt, "France is less expensive than Germany and less risky than the peripherals," says Martinez. 
  • 25 Feb 2013

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 17 Oct 2016
1 JPMorgan 310,048.18 1328 8.75%
2 Citi 285,934.48 1059 8.07%
3 Barclays 258,057.88 833 7.29%
4 Bank of America Merrill Lynch 248,459.06 911 7.01%
5 HSBC 218,245.86 884 6.16%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Oct 2016
1 JPMorgan 29,669.98 55 6.95%
2 UniCredit 28,692.62 136 6.73%
3 BNP Paribas 28,431.90 139 6.66%
4 HSBC 22,935.49 112 5.38%
5 ING 18,645.88 118 4.37%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Oct 2016
1 JPMorgan 14,593.71 79 10.38%
2 Goldman Sachs 11,713.19 63 8.33%
3 Morgan Stanley 9,435.23 48 6.71%
4 Bank of America Merrill Lynch 9,019.27 40 6.41%
5 UBS 8,763.73 42 6.23%