Hollande announced his proposed supply-side reforms Tuesday. Source: Thierry Chesnot/Getty Images.
Debt hits “danger zone”! Borrowing costs hit “worrying” levels! Investors “deserting”! These headlines have two things in common. One, they claim a French debt crisis is nigh. Two, they’re far out of step with reality. France might not have the world’s most structurally perfect economy, but it’s far from what these sensationalized headlines suggest—and looking ahead, French reality likely continues exceeding investors’ very dour expectations.
Driving French debt fears is a surface level analysis of the present situation. According to France’s National Audit Office, public debt is poised to hit 93.4% of GDP when 2013 tallies are in—over 30 percentage points higher than a decade ago. Benchmark 10-year yields have jumped from a low of 1.69% last May to 2.5%, and last week’s auction saw the weakest demand in a decade. The situation, though not of Grecian proportions, would seem to be moving in the wrong direction.
But a deeper look tells a different story. The widely quoted 93.4% estimate refers to gross public debt. In our view, a more meaningful measure is net public debt, which excludes debt owned by France’s Treasury—money the state effectively owes itself. France’s net public debt finished Q3 at 83.8% of GDP—not much higher than the US or UK, widely considered “safe” by investors. Thanks to falling yields in recent years, debt has remained relatively affordable. Total debt servicing costs closed 2012 at 2.6% of GDP—down from 2.8% of GDP in 2003, despite a lower debt load. Interest payments were 9.3% of tax revenue as of 2012 (the latest available data), also on par with the US and UK.
That rates are rising now doesn’t mean debt affordability automatically spirals out of control. France’s average debt maturity is seven years—low funding costs are locked in for a while—and rates aren’t guaranteed to skyrocket from here. Like US Treasury and UK gilt rates, they could very well move sideways or drift only modestly higher.
Yes, like the US and UK—yields are rising globally, even in countries generally considered to have minimal risk. This is another factor those fearing France’s debt “danger zone” overlook. French yields aren’t necessarily rising because investors suddenly consider French debt riskier. They’re rising in sympathy with long-term, high-quality sovereign interest rates broadly. US—long-term Treasury rates are highly correlated with long-term rates globally—Fed taper talk is a likelier culprit.
If investors saw France as a growing risk, French yields would likely rise significantly above the world’s benchmarks for sovereign solvency—investors would demand a higher interest payment as compensation for higher relative risk. But as shown in Exhibit 1, French yields aren’t exactly spiking relative to these alleged “safe havens.”
Exhibit 1: Benchmark 10-Year Yield Spreads
Source: FactSet, as of 1/15/2014. Difference between 10-year sovereign bond yields from 12/31/2009 – 01/15/2014.
Furthermore, rising long-term yields aren’t bad—with short rates still at historic lows, rising long rates mean a wider yield curve spread! France’s spread—like most globally—flattened in recent years, weighing on growth. Widening spreads now mean a persistent headwind is fading. That’s a big reason France’s Leading Economic Index has accelerated in recent months.
All that said, endlessly adding debt at a fast clip probably wouldn’t be great for France in the long run. French officials have admitted as much, and the last couple budgets have included spending cuts. Yep, cuts. President François Hollande has taken some flak for his Socialist Party rhetoric, but his policies are more moderate than his reputation suggests—deficit reduction has been a priority since he took office, and he has taken some small but symbolic steps to improve France’s overall competitiveness.
The latest step came Wednesday, when he announced measures to cut public spending by another €50 billion from 2015 through 2017 (on top of €14 billion in planned 2014 cuts) by streamlining government operations. He also heralded a “responsibility pact,” initially announced during his New Year’s address, where the government will scrap €30 billion in “family allowance” payroll taxes, cut red tape and offer additional tax incentives in exchange for a commitment to meet hiring targets and enhance training.
Politically, the reactions were mixed. Some Socialist lawmakers were a touch perplexed, but most offered cautious support based on Hollande’s stated adherence to party principles (ah, politics). Some members of the opposition Union for a Popular Movement also gave a tentative thumbs up. Then again, Hollande claims he doesn’t need broad political support—he hinted he could enact many of these plans through Presidential decree. Time will tell, but if he sees this through, such reforms could be long-term positives.
In the here and now, the importance is more symbolic. Investors broadly seem to expect a swelling state and eventual debt crisis. But reality shows France’s fiscs are better than perceived and leadership is inching along in the right direction. Like markets globally, it would seem French stocks still have a wall of worry to climb.