Exceptionalism has long characterised France. On the cultural front, two years ago the country requested the audio-visual sector (including French cinema) be excluded from the US-EU free trade agreement. The French labour market also has its own idiosyncrasies.
On average, the French work much less than their EU peers (186 and 239 hours fewer a year than the Germans and British respectively), mainly due to the controversial 35 hour work-week ensconced in law in 1998. Despite such policies being disconnected from the economic circumstances France is facing (figures on Friday showed that its economy stagnated in the second quarter), many reforms have been avoided. “L’exception Française” has shown itself again since the financial crisis, as French politicians steered clear of major public spending cuts, which have been progressively implemented by several of France’s neighbours.
France also displays diverging trends within institutional equity markets. Investors withdrew $1.5bn from French-focused funds (including mutual funds and ETFs) in the year to date, while funds investing in other Eurozone equities recorded inflows, based on our own research and Lipper data. For example, funds investing in German, Italian and Spanish companies have received $7.1bn, $673m and $159m of institutional money respectively. Surprisingly, the peak in outflows from funds investing in French equities occurred in February and March, just after Mario Draghi’s QE announcement, which was well received by European market participants.
Investors have been cautious on French equities since the beginning of the year, despite a positive first quarter economically. Declining oil prices and the depreciation of the euro versus the US dollar boosted local consumption and exports, leading to a GDP increase of 0.6 per cent in the first three months of the year (versus 0.4 per cent Eurozone growth). The ECB’s dovish monetary policy has kept interest rates artificially low, while working to pull European countries out of deflation.
As stagnant second quarter GDP figures perhaps show, these temporary effects are unlikely to raise France’s long-term growth prospects. There are four paramount areas of concern, which dampen French attractiveness from an investment standpoint.
First, the French labour market remains too inflexible. It is a long and expensive process to fire employees, while the hourly minimum wage is also relatively high. According to the OECD, labour market rigidity is the main drag on the country’s recovery.
Second, budget deficit targets are unlikely to be met this year, according to the Cour des Comptes chief Didier Migaud. Further deterioration might trigger the imposition of sanctions by the European Commission.
Third, total debt (at 95 per cent of GDP) might soon spiral out of control, with a negative impact on credit ratings, thereby raising borrowing costs and reducing foreign investment.
Fourth, the anti-euro, far-right party Front National is becoming a viable political group. Marine Le Pen’s momentum may be explained by the internal divisions and corruption scandals within the centre right party Les Républicains, led by former President Nicolas Sarkozy, and by President Hollande’s ongoing struggles, indicated by record unemployment since his election three years ago. Conflicts in the mainstream parties have become an asset for Le Pen, who is set to join the second round of the 2017 presidential election.
There have been some moves towards reform. Following his tumble in popularity last year, President Hollande reversed his stance by implementing a pro-business agenda, appointing reformist Manuel Valls as prime minister and former investment banker Emmanuel Macron as economy minister. This duo seems determined to devise and carry though structural reforms and budget cuts, despite fierce opposition from disenchanted socialists like Arnaud Montebourg.
Macron’s bold decision to bypass parliament to implement the Growth and Economic Activity Bill using constitutional article 49-3 is a reflection of the government’s eagerness to get things done. The fact that Socialists end up reforming the country more than the centre right is a French paradox, which may be explained by left wing governments’ close relationships with the country’s powerful unions.
Despite favourable external factors and the government’s new reformist stance, however, institutional investors have pulled money back from French equity-focused funds since the start of the year. Consequently, there has been less fresh institutional capital directed towards French companies.
To reverse this trend, France must tackle some of its most pressing issues. First, push through meaningful labour market reforms. Valls’s “Small Business Act à la Française”, which caps tribunal payouts to lower litigation costs, is a good start. Second, reduce government spending by fixing and/or reducing the unaffordable healthcare budget. Last but not least, raise the retirement age to match the cost of upcoming pensions. Under the current regime, France’s pension deficit is projected to reach 0.4 per cent of GDP in 2019.
This is no easy task, but investors are watching closely and scrutinising every move. Aux grands maux les grands remèdes.