Markets are taking a remarkably sanguine view of Frances
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, Frances
10-year government bond yield fell to 2.26% from a recent peak
of 3.72% in November.
By contrast, Romes 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
Pariss 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 Pariss penchant
for over-estimating GDP targets).
Whats more, according to BCA Research, France has
accumulated 60% more debt than Italy since 1999, while, in
aggregate value terms, Frances 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 Frances
At the heart of the issue is debt sustainability. Frances
debt-to-GDP ratio at 90% higher than the Maastricht
Treatys 60% threshold is 30 percentage points
lower than Italy.
Whats more, French president François
Hollandes 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.
|François Hollande, president of
Reaching this 2.7% target with a growing economy will
help lower Frances debt-to-GDP ratio, says
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 economys 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.
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.
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, its 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.
Whats more, France is expected to boast a larger
population of working age in the coming decades relative to
Italy, reducing Pariss fiscal strain with respect to
unfunded pension liabilities.
Finally, as Euromoney has reported, without a third round of
the European Central Banks (ECB) long-term refinancing
Italian banks could deleverage by up to 444
billion during the next two years, challenging growth
Nevertheless, the extent of Frances 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 governments 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.
Whats 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 Romes 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