Goldman Sachs brings bad news for the French economy

Guy Bentley
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Things aren't looking bright for the future of the French economy (Source: Getty)

One of the world's biggest investment banks is asking some probing questions about France's beleaguered economy.

Last week, President Francois Hollande's socialist government suffered a fresh blow when rating agency Standard & Poor's cut its credit outlook to negative due to the country's sluggish performance.

Here's what Goldman Sachs thinks the future holds for the world's fifth largest economy:

Will France continue to stagnate through year-end?

Goldman gives an unequivocal yes on this one thanks to poor domestic investment and the weakness in the Eurozone. In the first half of the year, France was stagnant with businesses overly optimistic about the level of demand in the economy, with inventories piling up. Looking ahead, things are unlikely to get better anytime soon with France's principal trading partners facing problems of their own.

Will French growth underperform the Euro area?

Another yes, with Goldman expecting consumer and business confidence to remain in the doldrums thanks to the uncertainty surrounding France's programme of structural reform and spending cuts.

Should we expect more structural reforms by the end of 2015?

Not likely.

Prime minister Manuel Valls has vowed to plough on with his predecessor's reforms, such as the Responsibility and Solidarity pact, which aims to cut the cost of labour by 30bn by 2016, but bolder reforms are not expected to brought forward before 2017.

The political environment has become increasingly hostile to reform, with a recent confidence vote squeaking through and the Socialists losing their majority in the senate. This makes reform increasingly tricky. Francois Hollande's rock-bottom poll ratings add to sense of malaise surrounding the government.

Does the 2015 French budget meet EU requirements?

Not by a long-shot.

France presented its new budget for 2014/15 on October 1. The budget deficit under current plans will reach the fall below the EU rule of three per cent of GDP until 2017. Furthermore, public spending is not projected to be cut at all over the budget horizon rather it will stabilise at levels seen in 2013 of 56 per cent of GDP.

However, its not just the latest budget that's giving Goldman cause for concern. Unless France can produce high primary surpluses, the economy could face severe problems from a rapid growth in public debt in the medium-to-longer term. Goldman believes France needs to speed up its fiscal consolidation to counter this threat.

Will France continue to fall behind in the race to improve competitiveness?

Highly likely, owing to the snail-like pace of reform.

French competitiveness ranks poorly even by European standards, with high taxes and burdensome regulations. Production costs in France also outstrip many of their European partners. Unit labour costs in France have been on the up since the beginning of 2013 and export growth has been on the decline. Reforms that have been announced will take time to kick in suggesting there will be no dramatic change to competitiveness in the short-run.

Is there a risk of deflation in France

Goldman gives three reasons why France is unlikely to experience deflation. First, France maybe stagnating but there is little chance of major recession. Second, nominal rigidities will counter deflationary risks in the short-run. Finally, Goldman doesn't expect any negative shocks from cuts in costs and wages.

Does France constitute a systemic risk to the Eurozone?

Thankfully not. For all the negatives afflicting the French economy, it still has a solid industrial base and a reasonably well-functioning banking system. A few of these industrial sectors remain competitive at an international level but there far too few. French debt is securely funded ensuring functional financial markets. Goldman believes these are the reasons France has been treated with relative leniency by financial markets.

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