Economist's "Time Bomb" Cover Angers France's Leaders, Bores its Lenders

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By Martin Baccardax | November 16, 2012 11:55 PM EST

The Economist: November 17th - 23rd 2012

As taken downs go, it was pretty tame.

The Economist is getting it from all sides of the French establishment after its cover story that labelled the world's fifth largest economy "The time-bomb at the heart of Europe", but the special report that details its case is actually far less incendiary.

The weekly newspaper highlights a series of well-established, and hardly controversial, facts that underscore the structural and potential weaknesses in the twin-engine of the Eurozone's core: high unemployment, profligate government spending, stifling central and local bureaucracy and rigid labour markets.

Government spending account for 56 percent of the country's GDP, according to Societe Generale. Nearly a third of GDP is spent on social protections (healthcare, welfare, etc) and 77 percent of that is funded by taxes on salaries and wages.

Published at a time when new President Francois Hollande is suffering plummeting approval ratings at home and the irritation of his European partners abroad at his "go-slow" approach to economic reform, French leaders have expressed a rare show of pubic irritation to the suggestion the France is Europe's new "sick man".

"France is not at all impressed by the excess aimed at selling more copies (of the magazine)," said Prime Minister Jean-Marc Ayrault.

Its Finance Minister, Pierre Moscovici, told the Financial Times that France is "not the sick man of Europe. France remains the world's fifth-largest economic power that has all its resources but which needs to recover its competitiveness."

But is the Economist's assertion really that extreme?

On paper, France's fiscal lethargy is troubling: it hasn't balanced the nation's books since 1974 and has run persistent budget deficits since 1981. The dismal run was enough to convince Standard & Poor's to clip its triple-A debt rating earlier this year.

But so far, the people who should be most concerned about that - its international lenders - remain sanguine. Ten-year bond yields fell from around 3.1 percent in January to 2.02 percent in early August, outperforming every other major bond market in the world at a time when global investors were hauling money out of the Eurozone's financial markets in the wake of region's peripheral debt crisis. Collectively, its overall borrowing costs have fallen from 1.98 percent in January to 1.88 percent in September, according to Reuters data, despite tapping the markets for more than €178bn.

Its benchmark CAC-40 stock index is up nearly 7 percent for the year and its economy successfully avoided recession in the third quarter with a surprise 0.2 percent advance and its government is on track to meet a previous budget deficit target of 4.5 percent of GDP (assuming it doesn't have to include the €2.6bn in state aid it used to rescue the Franco Belgian lender Deixia).

Financial markets are sometimes a blunt tool with which to measure economic performance, however, and the Economist's focus on labour market reforms and the need to stimulate competitiveness speak both to the core editorial remit of the newspaper (it would argue against bloated government budgets in Rwanda if given the space) and the concerns expressed by many of its senior business leaders.

One of those, the deeply respected former head of EADs Louis Gallois, was commissioned to issue a series of recommendations to the government on this very topic. His proposals include trimming welfare contributions to the state by around €30bn (around 1.5 percent of GDP) in an effort to jump-start French industry.

The government followed-up with €20bn in tax rebates (equal to around 1 percent of GDP and financed by a rise in VAT and some government spending cuts) to promote investment and employment.

The sums aren't trivial and the impact they could have on industry are significant. They also how, according to Barclays analysts, that Hollande's government understands "the urgency and necessity of accelerating the pace of reforms."

The government is also showing conviction in addressing some of the more sacred aspects of French economic life: employment protections and social security funding. In return, a banking reform bill will be outlined on 19 December that aims to crack down on so-called proprietary trading (ie making market bets with depositors' cash) and fulfil a popular campaign pledge from the President.

Bond markets, it's often said, represent a daily referendum on the government by its lenders. If this is true, they continue to be nonplussed by the Economists revelations: ten-year yields have narrowed to 2.07 percent Friday and continue to trade firmly. France's debt management agency, the AFT, has already closed the books on its 2012 debt raising and is said to be thinking about pre-funding the €170bn it will need for next year while its costs are at historic lows.

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