20 November, 2012

France downgrade

All the talk among European financial folk at the moment is of France. The Economist last week had its cover picture of baguettes tied with the Tricolour made to look like a primitive bomb; Wolfgang Munchau of the Financial Times by contrast yesterday listed France as one of the things he is not worried about in Europe, suggesting that the mood of French-bashing was politically motivated. Now this morning we learn that Moody's, like Standard and Poors earlier in the year, has taken away France's AAA credit rating.

The stakes are high. France is the second biggest economy in the eurozone. Even at this early stage the effects of its downgrade will be felt: when the rescue funds are leveraged - that is to say when they start to borrow against the guarantees of the constituent members, it is now only Germany, along with tiny Finland, Luxembourg and the Netherlands, which have the top rating; some lenders will not accept the collateral of a downgraded guarantor. So there may be less money to rescue the likes of Spain and Italy, should they need it.

Moodys observes that the chance of a rescue doesn't really apply to France. If Italy and Spain have to be rescued there will be no money left to help France, and if course it is in any case too big. Against that, it is tacit acceptance that France would not go under before Spain and Italy and neither of them has (yet) applied for help.

On the other side of the argument, there is a growing rift between the IMF and the Eurozone. Christine Lagarde started making impatient noises a year ago, hinting that the IMF had been set up to help poor nations, not rich currency blocs. Now she is openly stating that the creditor nations should take a haircut on their Greek debt. Der Spiegel shows how susceptible the various nations are to this. With a 60% haircut on Greek debt, for example, France would lose €55 billion, whereas the UK would lose only €2 billion. If it were Portugal as well, France loses €82 billion (UK €13 billion) and if we chuck Spain into the pot France, losing over €200 billion, would be insolvent.

But in my opinion blanket bad-mouthing is wrong. Yes, France has tied its lot too closely to the fate of the Eurozone, but that is what they all did pre-crisis. Yes, France has a problem of competitiveness, but Hollande has belatedly introduced tax breaks for small businesses, and it may well be that he is seeing the light.

France needs to watch it, and Germany needs to watch France, but it is a long way from disaster.

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