UNIQA Capital Markets Weekly

France: Same old structural story and Macron’s wind of change

• Election outcome and pro-European stance welcome by financial investors
• Besides a puffed-up public sector, the rigid labor market remains the most pressing issue to be addressed by economic policy makers

The French economy has been gathering some pace over the last two years (Figure 1). Still, in Q1 2017, growth in France’ real GDP (0.3 % q/q) lagged behind the total of the Euro Area (0.5 %). Growth in household consumption was weaker than previously (0.1 %) while fixed investment is gradually recovering (0.9 %). Inventories – a transitory component – made a large contribution to GDP in Q1.
Exports declined in Q1 (-0.7 %) and imports grew by 1.5 %. In annual terms, the French economy exhibited weaker growth (0.8 %) than by year-end 2016 (1.2 %). Real GDP growth projections hoover around 1.4 % annually until 2019. Although France has room to catch-up to the productivity frontier, long-term economic growth is estimated around 1.8 % annually (IMF); slightly above the Euro Area average and helped by less adverse demographic developments.

In its Article IV consultation report, the International Monetary Fund (IMF) criticizes structural rigidities and slow productivity weighting on medium-term growth prospects. Low international cost competitiveness vis-á-vis peer countries has repeatedly been stressed.
Apart from regulations in the services sector and a high tax burden, a key obstacle to growth remains the labor market, where structural unemployment is projected to remain high in the absence of additional reforms. According to the IMF, central policy challenges are to support a more rapid creation of new private sector jobs and to ensure sustainability of public finances via more efficient government spending growth.
Some important reforms have been advanced to help create the conditions for improved economic performance. These include the reduction in taxes under the Pacte the Responsabilité et de Solidarité and the Crédit d’Impot pour la Compétitivité et l’Emploi (CICE) and the competition-enhancing structural reforms under the “Macron” law (including, for example, the simplification of lay-off procedures and the streamlining of labor tribunals) and the “Rebsamen” law. Recent labor market initiatives were geared towards increasing the scope for company-level labor agreements and reducing judicial uncertainty.

The CICE has likely had a positive impact on corporate profitability which has recently stabilized. The fall in corporate investments seems over (+1.3 % in 2014, +2.7 % in 2015 and +4.3 % in 2016) and profit margins have been increasing (+31.4 % in Q3 2016).
Public finances remain strained. The IMF projects that total government debt to GDP will peak above 97 % in 2018 before falling afterwards (Figure 3). The total government deficit remained high at 3.3 % until last year. Social spending and the public wage bill are among the highest in the Euro Area. Public spending is around 57 % of GDP.

Recent reforms included a wage-scale freeze for all levels of government. The 2014 pension reform (higher rates and longer contribution periods for full pension) was complemented in 2015 by a reform of the supplementary pension. The budgetary target for health spending was tightened and indicative targets for local government spending growth started in 2015. Additional measures recommended by the IMF include limiting government spending growth to inflation (with burden sharing mechanisms) and institutionalizing spending reviews to improve efficiency at all levels of government. Large civil services should be streamlined and targeting of social benefits can be improved (unemployment, housing, families). The IMF proposes to further raise the effective retirement age.
Macron’s economic policy programme includes a further liberalization of the notoriously rigid labor market (Figure 4). In March, the unemployment rate was 10.1 % (Eurostat). Since 2000, the unemployment rate had averaged around 9 %. It had fallen to a low at 7 % before the 2008/09 financial crisis and peaked at 10.6 % in 2015. Employment growth has been low though positive since 2009 (0.7 % y/y in Q4 2016). Eventually, growth in hourly wages has already slowed since 2013.

Specifically, Emmanuel Macron aims to allow for labor law derogations in firm and sector agreements. In addition, he wants to add a 13th month for minimum wage workers. The current retirement age is kept (62 years) although the pension systems would be reorganized and standardized.

With respect to the tax code, Macron proposes a reduction of corporate taxes from 33.3 % to 25 %. Social contributions paid by employees, public workers and self-employed persons shall be reduced (decreasing the “tax wedge”, the difference between the total job cost paid and a worker’s net earnings). The infamous wealth tax shall be transformed into a real estate tax.

Concerning the real estate sector, economic policy proposals include the thermal renovation of one million poorly insulated homes by 2022 and the creation of a public fund of 4 bn EUR for precarious homeowners. 80 % of the French population should not pay housing tax. Additionally, a 10 bn programme for urban renewal was proposed during the campaign.

The digital economy and energy were further topics of the campaigned programme. This contemplates the creation of a fund for industry and innovation and a single European digital market.
Macron targets to transfer all administrative procedures to internet until 2022. Nuclear energy is reduced to 50 % in 2025 and a bonus of 1,000 EUR is proposed for buying a green car. A single European energy market is targeted (price floor for carbon). Concerning the public sector, Macron’s programme proposes to pass a law on moral in public life and reduce the number of members to the parliament and senators by 1/3.
Time for legislative procedures shall be shortened and control of government strengthened.

Finally, Macron’s programme is pro-Europe and pro-EU including the creation of a common Eurozone budget voted by the European Parliament and executed by a Eurozone finance and economy minister. A control mechanism for foreign investment shall be introduced in Europe.

The Macron victory is good news for financial markets. After the first round outcome, polls had been suggesting a clear Macron win for the second round. As the Euro Area economy is now doing fairly well and macro themes remain factoid, investors’ attention is likely to move on to satisfy its almost infinite appetite for volatility. Market risk spreads suggest that investor’s focus will – once again – shift to Italian politics as snap elections have been looming for some time (Figure 5).

CEE

• Czech Republic: May CNB monetary policy statement implying rate hikes in H2 and maintenance of commitment to intervene in FX market if needed

At the monetary policy meeting on 4th May, the bank board of the Czech National Bank (CNB) decided to keep interest rates unchanged at 0.05 % (2-week repo rate), 0.05 % (discount rate) and 0.25 % (Lombard rate). In April, the CNB had decided to end the exchange rate commitment to keep the CZK exchange rate vis-á-vis the Euro at 27. The exit from the exchange rate commitment was the first step towards a gradual return of the overall monetary conditions to normal. Subsequent interest rate increases will be conditional on the evolution of all key macroeconomic variables, including the exchange rate of the koruna. As previously, the CNB stated that it stands ready to use its instruments to mitigate potential excessive exchange rate fluctuations if needed.

According to the CNB’s new macroeconomic forecast, inflation will stay in the upper half of the tolerance band around the 2 % target this year and return to the target early next year. Consistent with the forecast is an increase in the domestic market interest rates in Q3 2017 and later also in 2018.

The growth of the Czech economy will rise to almost 3 % this year and maintain a similar pace next year. Growth is driven mainly by robust expansion in household consumption and a gradual recovery in investment. Rising tightness in the labor market will result in further acceleration in wage growth.

The CNB’s forecast assumes that interest rates will remain at the current level in Q2. Thereafter, an increase in domestic market interest rates in Q3 2017 and later also in 2018 is consistent with the forecast. The 3-months Pribor rate is projected to increase from around 0.3 % to circa 0.8 % over the course of Q3 consistent with two rate hikes in the 2-week repo rate (each 25 basis points). The 3-month Pribor rate remains flat in Q4 until Q3 2018 in the CNB forecast. The projection for 2018 assumes a further rise in the Pribor rate indicating additional (small) increases in the main policy rates in H2 2018. 

Over that horizon, the Czech koruna will appreciate due, among other factors, to continued real convergence of the Czech economy to the Euro Area and the appreciation will be fostered by a positive interest rate differential. On the other side, the CNB notes in its statement, that the appreciation may also be strongly dampened in the coming quarters by the market “overboughtness”. The koruna has appreciated slightly (0.7 %) since the abandonment of the FX commitment. After the policy meeting on Thursday, the EUR/CZK FX rate was 26.8. Current market forward rates imply a gradual appreciation to 26.7 until year-end and to 26.5 until end-2018 what seems consistent with the CNB staff projections.