Sarkozy’s ‘Stormy’ Week Brings Baby, Europe Debt Disputes With AAA Risk

Nicolas Sarkozy has reasons other than his first daughter’s birth to remember this week: Clashes with his two biggest neighbors, a warning that France may lose its top credit rating and polls showing he won’t be re-elected.

“It’s been a stormy time, a bit of a Bermuda triangle,” said Laurent Dubois, a professor at the Paris Political Studies Institute. “It’s a real challenge for Nicolas Sarkozy, for his record as the incumbent president. He needs to succeed during a full-blown economic crisis, the likes of which we’ve never seen before in the euro zone.”

The French president, whose wife had a baby girl on Oct. 19, is battling Germany’s Angela Merkel on the use of European Union rescue funds and was snubbed by Italian Prime Minister Silvio Berlusconi in the latter’s choice for the head of the Bank of Italy. Standard & Poor’s said France risks losing its AAA debt rating on the deepening financial crisis, while two polls showed Sarkozy would lose to his Socialist rival in the May 2012 presidential vote.

The confluence of the events threatens to weaken Sarkozy before he hosts the Group of 20 leaders’ summit on Oct. 23, with European governments negotiating a plan to unleash as much as 940 billion euros ($1.3 trillion) to fight the debt crisis.

Sarkozy, whose financial institutions have the most to lose from a potential contagion if Greece defaults, is trapped between two conflicting challenges: German opposition to France’s preferred solution for beefing up Europe’s rescue toolkit while at the same time risking a credit rating cut as a result of boosting the firepower of the region’s bailout funds.

Widening Spreads

The yield on France’s 10-year bonds climbed today to 3.2 percent from 2.6 percent at the end of September. That put the difference with German equivalents at 118 basis points, the widest since 1992, before the 1999 creation of the euro, based on Bloomberg data.

France and Germany have differed on bolstering the rescue funds for the region and its banks, a disagreement that prompted Sarkozy to head to a crisis meeting in Frankfurt the day his daughter was born. The 440 billion-euro European Financial Stability Facility has spent or committed about 160 billion euros, including loans to Greece running for up to 30 years.

Sarkozy wants to create a bank out of the EFSF, boosting its financial clout with backing from the European Central Bank, a proposal Germany rejects.

Split on ECB

“Everyone knows the reticence of the central bank and everyone also knows of the reticence of the German position,” French Finance Minister Francois Baroin said Oct. 19 in Frankfurt at the impromptu meeting of euro leaders. “For us it is and will remain the most effective position. The Americans do it, the British do it.”

The clash with Germany forced the scheduling of a second summit for Oct. 26, three days after the deadline set by Group of 20 finance chiefs for a debt-crisis fix.

The fund’s tasks include recapitalization of banks and buying bonds in primary and secondary markets.

At the end of March, French financial firms had $672 billion in public and private debt in Greece, Portugal, Ireland, Italy and Spain, according to Basel, Switzerland-based Bank for International Settlements. That’s the biggest exposure to the euro-area’s troubled countries and almost a third more than German lenders.

Credit Metrics

France’s increased contribution to the rescue fund together with its slowing economy may threaten its AAA rating. The country is among euro-region sovereigns likely to be downgraded in a stressed economic scenario, S&P said in a report today.

“Ballooning budget deficits and bank recapitalization costs would likely send government borrowings significantly higher,” S&P analysts led by Chief Credit Officer Blaise Ganguin in Paris wrote in the report. “Credit metrics would deteriorate sharply as a result.”

Two days after the split with Germany emerged, Italy’s Berlusconi wrong footed Sarkozy in the nomination of Ignazio Visco to run the Bank of Italy. The French president had expected Berlusconi’s choice to make room for a Frenchman on the ECB’s Executive Board.

The Italian premier had indicated he may choose ECB Executive Board member Lorenzo Bini Smaghi for the post, freeing up a seat for France. Sarkozy had made removing Bini Smaghi from the board a condition of his support for the Italian Mario Draghi’s candidacy to succeed the Frenchman Jean-Claude Trichet at the central bank helm.

French Representative

“The French obviously feel they should have a French member” on the board “and this nomination doesn’t solve the problem,” Marc Ostwald, a fixed-income strategist at Monument Securities Ltd. in London, said in an e-mail.

What’s more, two polls this week show that Sarkozy’s Socialist Party rival Francois Hollande will beat him by a large margin in the April-May elections next year.

Hollande would win 62 percent and Sarkozy 38 percent in a run-off, a poll by CSA for BFM TV and RMC radio showed on Oct. 19. Another survey by BVA for Orange, La Presse Regionale and RTL radio showed Hollande winning 64 percent to 36 percent.

In the face of all the challenges, Sarkozy -- whose new- born daughter Giulia is his fourth child -- can still prevail if he shows he’s the right man for France and for Europe, CSA pollster Jerome Sainte-Marie said.

“Sarkozy wants to paint his ability to manage the crisis as his main strength, to present himself as the only one who is capable, who has the experience, determination and energy to find an end to the crisis,” said Emmanuel Riviere, a political director at pollster TNS Sofres. “This is something that will be very important in the next four or five months.’

To contact the reporter on this story: Mark Deen in Paris at markdeen@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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