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Bond Buyers Take A Vacation From France

International International Business


Foreign investors who have fled Europe's bond markets recently have run especially hard from Paris. Their holdings of French government bonds plunged $19 billion in the five months through May, almost triple the net decline in their German portfolios.

Traders are spooked by what they see ahead in France. The 14-year reign of Socialist President Franois Mitterrand will end next May, and as the jockeying begins for next spring's elections, many traders fear reckless pump-priming by politicians before and after the voting. On the right, a dogfight among presidential hopefuls is exerting strong pressure on Prime Minister Edouard Balladur--who harbors presidential ambitions himself--to juice up the recovery and cut France's 12.7% unemployment rate. Key members of his Gaullist party are urging Balladur to loosen the franc's ties to the mark so interest rates can fall.

UPSET? The latest such call is from Jacques Chirac, a former mentor of Balladur's and his top rival for the presidency. In a slim new book that's on French summer reading lists--A New France--Chirac insists job creation takes precedence over all else, including a strong franc. Polls rank him a distant third with voters--behind Balladur and Socialist Jacques Delors, outgoing president of the European Commission. But the smart money is betting Chirac's control of the Gaullist party machinery will win him the presidency anyway.

Chirac's nationalistic outlook and go-for-growth mentality could hurt the franc, says George Magnus, an international economist at S.G. Warburg in London. Some observers fear Chirac might tamper with the autonomy granted the Bank of France this year to manage French monetary policy.

Balladur, a staunch champion of a strong franc, could withstand the pressure to soften his economic policies. He recently ordered government agencies to cut spending so he can trim France's growing budget deficit--another problem spooking the markets. Many critics, however, say his deficit-cutting has done little to tackle France's most sensitive budget problem, its underfunded health and retirement programs.

Economists think Balladur would be silly to loosen monetary strings because France's economy is finally recovering. J. Paul Horne, international economist at Smith Barney Shearson Inc. in Paris, says colleagues considered him "a raving optimist" in January, when he forecast 1.4% growth for France this year. But recently, Horne hiked his forecast to 2%. Industrial production is rising, and companies have stopped cutting inventories and investments. Even unemployment should start falling, though it will probably stay high because of an industrial-restructuring binge.

PARTY GAMES. Such factors should favor a Balladur candidacy--if he can win party backing. Some conservatives want to organize France's first primary elections this fall or winter to let voters pick a single candidate to carry the conservative banner. Rivalries on the right helped Mitterrand win in the last election. So far, however, the conservative parties can't even agree on primary rules.

France's battered Socialists have the opposite problem: no credible candidate, except for Delors. The former French Finance Minister has never run for public office and may not want the presidency. Even if he does, a French backlash against European integration could dim his popularity. Former top candidate Michel Rocard has little hope after a miserable Socialist showing in June elections for the European Parliament.

France's electoral muddle is unfairly hurting the Gallic image in financial markets, complains Michle Debonneuil, chief economist at Banque Indosuez. The "risk premium" for French bonds has soared, expanding the gap between French and German bonds from 9 basis points in January to 45 points now. Some analysts think the gap may widen further this fall.

Yet Debonneuil argues that economic fundamentals are as sound in France as they are in Germany, even though "France must pay strongly for the least political shadow." She insists France couldn't decouple its economic policies from those of Germany--its main trading partner--even if it wanted to. Still, money managers fear France's present or future rulers may be tempted to try.Stewart Toy in Paris

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