Hollande Struggles to Match Sarkozy Budget-Gap Wins
Few bond investors expect French President Francois Hollande to match Nicolas Sarkozy’s facility for beating deficit targets.
In the post-recession years of 2010 and 2011, former President Sarkozy bettered his own budget goals. Hollande, who has pledged to cut the deficit to 3 percent of gross domestic product next year from 5.2 percent in 2011, risks ending that trend. His government unveils its 2013 budget tomorrow.
Plugging a budget hole of more than 30 billion euros ($39 billion) next year against a backdrop of an economy that hasn’t grown in three quarters and joblessness that’s at a 13-year high will be a tall order, investors such as Dagmar Dvorak at Baring Asset Management say. Failure to do so may drive money away from French debt, which commanded record-low yields under Hollande.
“It will be a tough balancing act for Hollande’s government,” said Dvorak, a director of fixed-income and currencies in London at BAM, which oversees $50 billion. “More austerity in this tough environment means lower growth unless you have a very strong export sector to support you. The country’s exporters are suffering as well. The country needs to maintain fiscal discipline to win investors’ support.”
Faced with riskier debt in Italy and Spain and lower yields on German securities, investors have ploughed into French bonds. The yield on French 10-year debt dropped to a record-low of 2.002 percent on Aug. 3 and was at 2.19 percent at 1:28 p.m. in Paris. France has also borrowed at historically low costs in bond auctions, including at negative yields on short-term debt.
Standard & Poor’s, which stripped France of its AAA credit rating on Jan. 13, said this week that declining yields of government debt in the euro area’s so-called core is partly explained by the Swiss National Bank’s 80 billion euros of purchases, a claim the central bank calls “unfounded.”
Some of the concerns about France’s fiscal situation are percolating into debt markets. French bonds handed investors a 0.2 percent loss this month, underperforming their Austrian and Belgian peers, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies.
“While we don’t expect French bond yields to go in the direction of Italian or Spanish bond yields, we are worried about its fiscal outlook,” Dvorak said. “If France fails to meet its fiscal target or has to backpedal on some of the austerity measures the government puts in place to boost growth, we may reduce holdings further.”
The premium demanded by investors to hold French 10-year debt rather than comparable German securities fell to 72 basis points today from a euro-era high of more than 200 basis points on Nov. 17, and that’s not warranted, said Stuart Thomson, a portfolio manager at Ignis Asset Management in Glasglow, U.K., which oversees $110 billion.
“If there’s one country in the core market that we’re concerned about, it’s France,” said Thomson. “I don’t think France’s current bond spread to Germany is justified. It doesn’t reflect the economic and fiscal risks. I will be a buyer of French bonds at a 100 basis-point spread or above. And I call myself a low-maintenance investor. A high maintenance one would ask for at least 150 basis points.”
Hollande, who’s targeting a deficit of 4.5 percent of GDP this year and 3 percent in 2013, is unlikely to meet them, JPMorgan & Chase Co. says.
“We see this as ambitious,” Alex White and Raphael Brun- Aguerre, JPMorgan analysts, wrote in a report dated Sept. 21. “The low-growth environment will likely weigh on fiscal revenues, making the target hard to achieve.” They see budget gaps of 4.7 percent of GDP in 2012 and 3.3 percent next year.
At the end of the last global recession in 2009, France’s deficit reached a record 7.5 percent of GDP. For the following year, Sarkozy predicted a budget deficit of 8.5 percent of GDP. It came in at 7.1 percent. In 2011, he achieved 5.2 percent, beating his target of 6 percent.
Hollande has consistently said that he expects to meet his deficit targets. To do that for next year, he pledged 20 billion euros in tax increases and 10 billion euros in spending cuts.
“Some in the markets take a more favorable view of a skew towards spending cuts rather than tax hikes,” said Richard McGuire, a senior fixed-income strategist at Rabobank International in London. “With spending cuts you always know what you are going to save. You never know what you are going to garner from higher taxes.”
Spending cuts will be hard for the Socialist president.
Since returning from his summer holiday six weeks ago, Hollande promised to shrink the deficit, implement a European treaty on fiscal discipline and press unions to accept increased labor flexibility by year end. Over that period, his approval rating dropped by 11 points to 43 percent, according to an Ifop poll released this week.
“Hollande is facing the political consequences of having run against austerity, but asking France to take tough fiscal medicine,” the JPMorgan analysts wrote.
Rebellious lawmakers in Hollande’s own party oppose the ratification of the euro area’s deficit-capping fiscal pact and he faces a call from the CGT union for protests against austerity on Oct. 9.
As French companies such as PSA Peugeot Citroen SA and Air France-KLM Group cut thousands of staff amid slowing growth, unions have been questioning the wisdom of holding to the deficit target, making labor unrest likely in the months ahead.
Hollande has tried to sell his debt and deficit-cutting push evoking sovereignty, saying he doesn’t want to be beholden to the markets. In his televised Bastille Day interview on July 14, he said that “efforts” and “patriotism” are required.
Investors including Rabobank’s McGuire say the diminished expectations on deficit cuts may not be bad for French bonds.
“If the government chooses to raise the deficit target, the response from the market might not necessarily be negative,” he said. “There might be come degree of flexibility on the part of the market because some investors have firmly entrenched in their view that austerity measures are self- defeating. So perhaps a more realistic approach in terms of budget deficit target that can be achieved in the current growth environment would not be taken badly.”
Still, failure to meet the targets would put Hollande’s credibility at risk.
“The success or otherwise of the likely political response to the budget will provide a good indicator of how much political capital the government will have to maintain its adherence to whatever fiscal path it lays out,” wrote JPMorgan analysts White and Brun-Aguerre.