France: How much should we worry?

Following a steady improvement in business sentiment in recent months, yesterday’s flash PMIs provided a reminder of the fragile state of the euro area’s recovery. The region’s composite PMI – a useful guide to economic growth – unexpectedly fell in February, almost fully reversing last month’s gain and signalling a contracting economy for the thirteenth consecutive month.

Given the exceptionally strong rise in Germany’s PMI in January, we had already anticipated, to some extent, a correction in this month’s figures. However, while Germany’s PMI slipped back broadly as expected, we were surprised by the renewed and marked deterioration in sentiment in France, where the composite PMI extended the previous month’s fall to hit its lowest level in nearly four years. Although this contrasted with the picture painted by the latest INSEE sentiment index, which ticked up in February, leading indicators for the euro area’s second largest member state currently raise eyebrows about France’s near-term growth prospects.

Euro area: Composite PMIs by major economiesComposite Pmis

Source: Datastream

Following no growth in 2012, we now expect a shallow full-year contraction in French GDP of 0.1% this year. But there are risks, of course, that things could turn out a lot worse. And the moribund growth performance will have consequences for France’s public finances. Indeed, comments by finance minister Moscovici earlier in the week suggested that France’s government is likely to abandon its budget deficit target of 3% of GDP this year as soon as it accepts reality and revises down its own overly optimistic 2013 growth forecast of 0.8%.

With growth absent and the government hesitant to embrace significant spending cuts, we estimate that France's budget deficit in 2012 narrowed only marginally, remaining close to 5% of GDP. More worryingly, and as an indication of the significant efforts required to restore health to the public finances, France’s primary deficit last year is likely to have been one of the euro area’s largest, and higher than those of Portugal and Greece combined. And with the bloated government’s spending amounting to an unsustainable 57% of GDP, compared to 49% in the euro area as a whole, we believe France's only chance to meaningfully reduce its deficit will be to slash drastically expenditures as revenues will remain subdued in the face of a stalled economy.

But with French President Hollande perhaps justifiably opposed to more austerity at times of recession, we doubt that the political will exists to find the prerequisite extra spending cuts over the near term. We therefore expect France's budget deficit to remain above 4% this year, possibly raising prospects of a further credit rating downgrade (and further disagreements within the Eurogroup) later in the year.

But it is not all bad news from France. In January, following months of negotiations, representatives of three of the country’s largest trade unions and employer associations reached a landmark deal on wide-ranging labour market reforms. The measures, which are scheduled to be signed into law in April, will help companies align wage costs more closely with economic conditions, addressing a key driver of the surge in the country’s unemployment rate to close to a 14-year high of 10.6% in December. They should also help to achieve a more level playing field between workers on full-time and temporary work contracts, the latter of which have accounted for nearly 80% of recent hiring activity, and so provide greater incentives to firms to hire workers on a permanent basis.

Overall, we view very positively these French labour market reforms, which compare particularly favourably against last years’ disappointing efforts in Italy. And while the experience of Germany has taught us that such reforms need time to reveal their full impact, if accompanied by other efforts to increase product market flexibility, we are confident that they will eventually help to rejuvenate France’s sclerotic economy and raise its medium-term growth prospects.

In the near term, however, France’s recovery will struggle to gain traction. Consumption will remain sluggish, while the continued deleveraging of the country’s banking sector will constrain investment. And although net exports contributed for the first time in 15 years in a meaningful way to growth last year, French exporters will continue to suffer from a lack of price competitiveness. But if President Hollande remains committed to reforming the French economy, and acknowledges the need for more courageous structural government spending cuts, we will remain confident that France will be able to steer clear of any future market turmoil.


Tobias S. Blattner
Euro area Economist

Categories : 

Back to research list


This research report is produced by Daiwa Securities Co. Ltd and/or its affiliates and is distributed by Daiwa Capital Markets Europe Limited in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by the Financial Conduct Authority and is a member of the London Stock Exchange, Eurex and NYSE Liffe. Daiwa Capital Markets Europe Limited and its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.


This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.


Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at Regulatory disclosures of investment banking relationships are available at


For more details, please contact:

Grant Lewis, Economic Research
Daiwa Capital Markets Europe Limited
5 King William Street, London, EC4N 7AX

+44 (0)20 7597 8334


For up to date Research analysis, see our blog site here.

Sign up for news/events alerts