The Franc Fort Is Under Siege

The French economy begins 1995 amid excellent prospects for solid, noninflationary growth. The same for Germany. So why has France's "strong franc" been losing ground to the German mark?

It's hard to make a rational case for franc weakness. Most analysts expect French economic growth, led by exports and capital spending, to accelerate this year to between 3% and 31/2% from an expected 2.4% in 1994. Strong exports will help France maintain its trade surplus. And consumer inflation, which dipped to a 40-year low of 1.6% in November, will stay down. Slack labor markets--November joblessness held at a near-record 12.6%--will mute wage and price pressures and keep inflation near the Bank of France's 2% goal.

But currency markets aren't always rational. Right now, the franc is the victim of Eurocurrency turmoil. Portfolio shifts out of swooning currencies have favored the safety of the mark at the franc's expense. Also, the political uncertainty surrounding the French presidential elections this spring has made the markets jittery--perhaps overly so.

Neither of the key candidates--current Prime Minister Edouard Balladur and Jacques Chirac--is likely to tamper with the franc fort policy of linking France's monetary policy to Germany's, and both have endorsed fiscal moderation as a needed step toward an eventual European monetary union. Moreover, Balladur, the financial markets' favorite candidate, leads all the polls.

One stumbling block for the franc could be the French government's slower pace of fiscal improvement. The 1994 fiscal deficit stood at 5.7% of gross domestic product vs. Germany's 2.7%. European markets are increasingly rewarding those countries that show the political will to get their finances in order while punishing those that do not. That means maintaining the franc fort will not only demand higher interest rates but it may also require tax hikes at a time when domestic demand is already limited by chronic unemployment.

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