Will France be at the heart of the next Eurozone crisis?

14th January 2014


It is difficult to divorce historic rivalry from economic fact in assessing France’s current troubles, but there seems to be little doubt that the world’s fifth largest economy is having a rough patch.

Borrowing costs are rising, economic growth is anaemic, exports are weakening and labour inflexibility is deterring external investment. The question, however, is less whether the French economy is rubbish – much though many Brits would like to cock a snook at their long-term sparring partners – but whether French weakness has the ability to destabilise the Eurozone’s fragile recovery.

There have been no shortage of articles drawing attention to the contrasting recoveries in France and the UK. As thisismoney.co.uk reported recently: “Gross domestic product in the UK rose by 1.9 per cent in 2013, the strongest pace of expansion since 2007, according to research group Markit. It said private companies took on another 150,000 staff in the final three months of the year as the recovery picked up pace…” and in contrast: “France was the only major economy in Europe to see its private sector shrink in December – suggesting the country has tipped back into recession.”

There are also more pressing concerns for France, notably its rising borrowing costs. Its economy has sustained high spending levels largely because it has been able to borrow at relatively low cost.

This is changing. As the Telegraph reports:  “The ten-year bond yield climbed as much as 4.5 basis points on Wednesday (last week) as a gauge of activity in its manufacturing sector slipped to a seven month low, to the lowest of the Eurozone’s major economies.”

It is also moving in a different direction to the remainder of Europe. In countries such as Spain, government borrowing costs have been moving closer to those of Germany, reflecting their stronger financial position and the steps they have taken to address their deficits. They are now at their lowest level since 2011. France is going in the opposite direction.

There are plenty of reasons why France is an isolated case and not symptomatic of the wider Eurozone. Its labour laws, for example, are inflexible and naturally discourage external investment, says Clive Hale, partner at Albemarle Street Partners: “France’s biggest problem is its inability to resolve its labour issue. It is difficult to sack people, so companies don’t want to invest. It is easier to open a factory elsewhere.” In many cases this will be elsewhere in the Eurozone, so for the long-term strength of the bloc it makes no difference, but this is not universally true.

Equally, its political situation also appears to be uniquely bad. President Francois Hollande was swept in on an anti-Sarkozy wave of socialist fervour, only to prove inept in the eyes of most political commentators now. As the Guardian reports: “Hollande is already the most unpopular French president on record and can expect to face further charges of economic incompetence after the mainstays of French output and employment failed to reverse their fortunes ahead of the Christmas break.” With an approval rating of just 26%,

Hollande no longer has a strong mandate to push through any reforms even if he were to change his agenda.

The country has not been able to reverse the decline in competitiveness brought about by joining the Euro, says Neil Williams, chief economist at Hermes Fund Managers. He says: “(The country’s) lost ‘triple A’ ratings reflect a failure to reverse its 8% competitiveness hit with the euro. This dwarfs Portugal’s 1% loss, which is a bail-out country rated 9-11 notches lower than France. France still looks vulnerable: there’s been little consumption front-running ahead of VAT-hikes on 1 January, and the new 75% employers’ income-tax rate for high earners. These will erode France’s position further, making recession inevitable; and its debt position is high and deteriorating. France’s net debt-to-GDP will climb to 76% in 2014 from 45% 10 years ago.”

Things look bleak for France. And while these problems remain largely unique to France, it is difficult to see how there cannot be some impact on the wider Eurozone recovery. Neil Staines, head of trading and execution at the ECU Group – goes as far as to suggest that France may be the source of the next wave of the Eurozone crisis: “We have long highlighted our view that the next stage of the eurozone crisis will not be at the periphery, but at the core and have frequently highlighted the significant structural weaknesses of the FISH: France, Italy, Spain and Holland. France is becoming increasingly worrying the socio-political backdrop particularly, as growth falters in Europe’s second largest economy, the economic divergence between it and the largest economy Germany, perhaps pose just as large a concern for the ECB as the weakness itself.”

France remains central to pan-European trade. It is the second largest trading nation within Europe and its weakness will be felt across the country. Within its import market, Germany is most exposed at 19.5%, then Belgium (11.3%), Italy (7.6%), Spain (6.6%) and the Netherlands (7.4%) – Source: CIA

While Germany, Spain, Italy and the other large Eurozone powers continue to see momentum in economic growth, France’s problems can be set to one side, but should the fragile recovery derail, France might find its position more difficult and drag the rest of the Eurozone with it.

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