Markets are taking a remarkably sanguine view of France’s fiscal position, even with a socialist president launching a raid on the wealthy – at a potential cost of depressing medium-term economic growth.
For example, on Monday, Paris sold six-month treasury bills with a negative yield. Earlier this month, France’s 10-year government bond yield fell to 2.26% from a recent peak of 3.72% in November.
By contrast, Rome’s yield curve is under structural buying pressure, with the 10-year note frequently breaching the psychologically important threshold of 6% in sympathy with the twists and turns of the eurozone crisis.
At first blush, the extent of this divergence between Rome and Paris’s borrowing costs seems striking. After all, during the past decade, Italy has run non-trivial primary budget surpluses – which do not include interest costs – while France tends to run large deficits, with weak medium-term budget planning. (The four consecutive supplementary budgets in the 2012 fiscal year is a testament to Paris’s penchant for over-estimating GDP targets).
What’s more, according to BCA Research, France has accumulated 60% more debt than Italy since 1999, while, in aggregate value terms, France’s combined private- and public-sector load is larger than in Italy.
However, on the basis of fundamentals, Michel Martinez, Paris-based economist at Société Générale, says political stability, a lower debt-to-GDP ratio, economic outperformance and a more attractive demographic profile account for France’s outperformance.
At the heart of the issue is debt sustainability. France’s debt-to-GDP ratio at 90% – higher than the Maastricht Treaty’s 60% threshold – is 30 percentage points lower than Italy.
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| François Hollande, president of France |
What’s more, French president François Hollande’s recent success in the legislative elections has given him the flexibility to tighten the fiscal screw. The government is expected to record a public deficit figure lower than 2.7% by 2014 – though GDP undershooting government estimates represents a downside risk.
“Reaching this 2.7% target with a growing economy will help lower France’s debt-to-GDP ratio,” says Martinez.
However, markets fear that in Italy, like Spain, the real rate of government debt interest payments will leap above the real rate of growth, exacerbating the economy’s high debt-to-GDP ratio. Economic output fell by 0.8% in the first quarter of the year, after a 0.7% drop in the fourth quarter of 2011.
Positive feedback
By contrast, a positive feedback loop has emerged in France, says Martinez. “French treasuries are expensive, which reinforces their attractiveness for other European investors thanks to the perception of quality and stability in the investor base,” he says.
The eurozone crisis has triggered a collapse in non-resident bids for peripheral European government debt, but in France some two-thirds of sovereign paper is held by foreign investors compared with one-third in Spain.
“While this makes France, in a sense, more vulnerable to foreign investor outflows if concerns emerge about the public finances, it’s a strength at the moment given the expansion of the investor base,” says the SocGén analyst, citing how France has benefited from collateral demand from banks and non-bank intermediaries.
What’s more, France is expected to boast a larger population of working age in the coming decades relative to Italy, reducing Paris’s fiscal strain with respect to unfunded pension liabilities.
Finally, as Euromoney has reported, without a third round of the European Central Bank’s (ECB) long-term refinancing operation, Italian banks could deleverage by up to €444 billion during the next two years, challenging growth further.
Nevertheless, the extent of France’s outperformance – with spreads over German bunds staying at 100 basis points – is surprising given the eurozone headwinds and associated financial dysfunction.
And, as Martinez puts it: “The government’s fiscal consolidation proposals rely too heavily on tax increases, rather on a spending freeze, which will weigh on the medium-term growth potential of the economy.”
Indeed, there is little appetite for structural reforms in France, unlike in Italy.
Meanwhile, Italian sovereign debt has an average maturity of around seven years, one of the longest yield curves in the eurozone, and household wealth amounts to €8,600 billion compared with the public debt of around €2,000 billion.
What’s more, Italy can begin to defuse its debt bomb by 2014, reckons Credit Suisse. “A lower deficit and direct measures on the debt front should allow a stabilization of the debt/GDP ratio below 125% in 2012-3, followed by a reduction from 2014,” it states, citing labour market, energy and tax reforms.
In the short-term, at least, hawks in Berlin and the ECB will determine Rome’s fate as they attempt to strike a balance between crisis-management and a policy of benign neglect – seeing selling pressure on non-Germanic government bonds as positive for reforms.
Source: Credit Suisse