The "No" That's Shaking Europe

French voters' rejection of the proposed EU constitution may mean that, in a nutshell, the treaty is dead. And the fallout could be widespread

By Beth Carney

France's resounding defeat of the European Union constitution in a referendum on Sunday, May 29, hasn't quite ended debate on the controversial document intended to draw the 25-member bloc closer. The Netherlands still goes to the polls June 1 to deliver its verdict on the pact. Yet the rejection by France, a founding member of the EU that has participated in every step of the region's integration, puts the treaty's adoption in serious doubt.

In France, the vote has led to political upheaval. Prime Minister Jean-Pierre Raffarin resigned Tuesday, and President Jacques Chirac appointed Interior Minister Dominique de Villepin to replace him. Across Europe, the decisive non vote raises questions about the future of European economic integration, and the prospects for further market reform. "It's bound to be associated with some financial instability," says Dario Perkins, European economist at Dutch bank ABN Amro.

The 448-article constitution, approved last June by Europe's leaders, aims to simplify governance of the recently enlarged EU and enable it to function more efficiently. Among the new provisions are rules extending the types of policy decisions that can be made by a majority vote rather than by unanimous agreement. The charter also creates the positions of President and Foreign Minister and outlines which government functions Brussels will oversee.


  Since all 25 members must ratify the constitution before it becomes law -- nine countries have already done so -- France's rejection effectively derails the process. Although in theory France could hold another referendum, the pact's repudiation by 55% of voters in a typically pro-European country greatly increases the likelihood that the charter will encounter opposition in other nations. "In a nutshell, the treaty is dead," says Daniel Keohane, senior research fellow for the Center for European Reform in London. "I think it will be very difficult to continue with ratification."

Polls predicted the French vote, which doesn't threaten the existence of the EU itself or the monetary union. Yet the defeat is seen as a blow to further European unification, with a number of potential economic effects.

One could be a weakened euro. The 12-nation currency had already slid against the dollar by just over 7% during the year before the vote, a move that some analysts say can be partly explained by the expectation of the no vote in France. In light trading Monday, a holiday in both the U.S. and Britain, the euro slipped further, to $1.247, at the end of Europe's trading day from $1.2583 in New York Friday afternoon.


  Increased uncertainly about Europe's future could sustain pressure on the currency, say analysts. David Woo, global head of foreign exchange strategy at Barclays Capital, says the no vote could weaken the currency by limiting European governments' ability to put peer pressure on members to exercise fiscal responsibility. "In the long term, this French no vote is clearly very negative to the euro, and it's going to undermine the euro's status as an alternative reserve currency," he says.

A weaker euro isn't necessarily unwelcome, as it could be a boost for the region's exporters. But offsetting the benefits of a potentially weaker euro are the negative, longer-term effects that the constitution's rejection could have on future economic reform, analysts say. Although French opposition to the treaty had many sources, one message that came through clearly was voters' frustration with the EU-promoted economic liberalization.

Philippe Tibe, head of research in France at UBS bank in Paris, notes that on both sides of the constitution debate, campaigners invoked opposition to a free-market, "Anglo-Saxon" model of capitalism that French voters have come to identify with the EU. Constitution proponents presented the document as a means of protecting France against the spread of market liberalization, while critics claimed the treaty would accelerate reforms, he says.


  The widespread support for France's social state expressed during the campaign means the pace of economic reform there will very likely slow, says Tibi, who expects to see more state intervention in the market and fewer privatizations. Delay to further reform could have "a negative effect on perception of French stocks, particularly those where change is needed," wrote Tibe in a note analyzing the possible effects of the vote.

Moreover, the French vote could signal trouble for increased market liberalization throughout the region, other analysts say. Already, France and Germany have objected to the EU's proposed services directive, an initiative that would make it easier for European service providers to compete across borders within the union, says Michael Hume, senior European economist with Lehman Brothers in London. A no vote, he says, confirms that "the European economy will still be resisting changes."

Another near-term effect is likely to be a widening of spreads on European government bonds. Until now, investors have tended to regard the euro-zone as a unit, with spreads between the debt of countries with different economic climates and fiscal policies remaining relatively tight. The market doesn't believe that the EU would allow a member to default, says Jean-Francois Mercier, European economist with Citigroup in London.


  Yet in the wake of the French vote, and the signal it sends challenging European integration, investors may start to pay attention to the varied economic performances of different countries and factor more risk into the bonds of countries such as Italy, which is in recession and has a higher debt level than its peers, say analysts, "The more there is rejection of Europe and integration by voters, the harder it would be for EU authorities to bring back into line a country that drifts away," says Mercier.

Notably, the countries likely to be the most hurt by the French vote are not even EU members but candidates for future membership, in particular Turkey, which is due to start accession talks in the fall. Not only does the lack of a constitution increase the likelihood that the admission process could be delayed but the French vote is seen as a vote against enlargement in general, and it could increase political pressure to exclude new members. A May 23 note put out by Credit Suisse First Boston on the impact of a no vote said: "Turkey is likely to be the biggest loser."

The deadline for ratification is November, 2006, and some analysts say there's time to salvage the process.  Mercier points out that polls before the election showed that the 55% of French voters believed that France would be able to renegotiate the pact after voting no. Yet with polls showing that the Netherlands' nonbinding referendum is likely to follow the path of France, European leaders are expected to discuss their options at a meeting in Brussels scheduled for June 16. Clearly, the future of the charter, and Europe's economic integration, remains uncertain.

Carney is a reporter for BusinessWeek Online in London

Edited by Phil Mintz

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