France is once again at the center of Europe’s economic worries, with a new report from BCA Research warning that the country’s debt troubles are too severe for the European Central Bank to resolve.
“France is in trouble,” BCA Research said. The warning comes just days before Prime Minister François Bayrou faces a confidence vote on September 8, which his minority government is expected to lose. But BCA stressed that even if Bayrou survives, the underlying problem remains.
France is carrying the highest debt burden in the G7 outside Japan. Government debt stands at 115% of GDP and private sector borrowing adds another 210%, lifting the country’s total debt ratio to 325%.
Canada, at 310%, is the only major economy that comes close. According to BCA, “a total debt ratio above 300% tends to be unsustainable.”
Debt sustainability ultimately depends on the relationship between growth, interest rates, and the primary deficit.
On this score, France’s outlook is deteriorating fast. The report calculates that France’s deficit excluding interest payments cannot exceed 2% of GDP if debt levels are to stabilize.
Yet, without sharp spending cuts or tax increases, the deficit is on course to reach 3.5%. “France has the worst primary deficit in the G7,” BCA said.
Some investors may look to the ECB to ease the pressure, but the report argues that the central bank is powerless to address the country’s underlying solvency issues.
“The ECB’s tools can solve a liquidity crisis, but they cannot solve a solvency crisis that requires a reduction in the government’s deficit and debt,” the brokerage noted. Lowering borrowing costs would only risk “rekindling a private sector credit boom” and making matters worse.
Bond markets are already reacting. French government bonds, known as OATs, are underperforming against peers.
UK gilt yields are offering record premiums over French paper, a sign of investors demanding more compensation for holding France’s debt.
BCA advised investors to stay underweight OATs both relative to cash and to gilts.
The brokerage warned that bond vigilantes are circling several advanced economies, but France is “the most vulnerable because of a toxic combination: a total debt ratio well above 300% plus the worst primary deficit in the G7 plus political gridlock.”
Equities in Paris face risks too. The short-term picture is weak, though the longer-term case rests on global luxury and cosmetics companies that dominate the CAC 40.
“The structural driver of the French stock market is not the French economy per se, but the outlook for its dominant sectors,” BCA said, pointing to LVMH and L’Oréal.
ECB liquidity can’t solve France’s liquidity squeeze, but tough political decisions are required to deal with its solvency crisis. “France needs a political solution,” BCA warned, adding that “it may take the bond vigilantes to force France’s destiny.”
Source :
https://www.investing.com/news/stock-market-news/france-is-in-big-trouble-again-can-the-ecb-save-it-4225953
