France basks on bond market, but must cut deficit

France needs to borrow 170 billion euros ($220 billion) next year but the rates at which it borrows are likely to remain low provided it holds to targets for cutting the public deficit. Another factor playing in favour of low borrowing rates for France, despite the "critical" state of its debt, is the high risk associated with bonds issued by Greece, Portugal, Spain and to a lesser extent Italy. Risk aversion has driven funds into assets regarded as relatively secure, and so far this asset class includes French government bonds. The borrowing target emerged with details of the budget for next year, presented on Friday. The budget is intended to raise taxes and cut spending by a total of 36.9 billion euros ($47.6 billion), against a background of unexpectedly weak growth, to reduce the public deficit from 4.5 percent of gross domestic product this year to 3.0 percent in 2013, in line with a European Union limit. Finance Minister Pierre Moscovici, presenting the new Socialist government's first budget to the public finance committee of the National Assembly (parliament), warned the country's debt is approaching the danger zone. "We are now at 91 percent (debt to output), which is an absolutely critical level as it is accepted by every economist that debt above 90 percent represents a sustained threat to growth." This year France has been able to borrow at exceptionally low levels, even at theoretically negative rates for some short-term debt since the beginning of July. Even though one of the leading credit rating agencies, Standard&Poor's downgraded its prized triple "A" rating for France in January, France has been able to borrow for the medium and long term at rates of less than 2.0 percent. The French debt management agency AFT describes these rates as "a record". These conditions mean that the cost of servicing the debt this year could turn out to be 2.1 billion euros less than the finance ministry had planned for a year ago. -- Structural reforms needed -- Several economists contacted by AFP hold that these conditions are likely to continue in coming months. At Oddo Securities, chief economist Bruno Cavalier, said: "For as long as unfavourable winds buffet countries in the south of the eurozone, and particularly Spain, investors will continue to have an interest in looking for safety and in looking towards French debt." Two other top rating agencies, Fitch and Moody's, still give France an "AAA" rating although Moody's is due to say in October whether or not it will maintain this. At Natixis bank, Jean-Francois Robin commented: "This means that France is regarded as having this rating by professional investors (such as pension funds and institutional investors) which have to hold assets of this quality in their portfolios." The risk that France could slip into recession should not therefore discourage investors. At Credit Agricole bank, economist Frederik Ducrozet commented that "the question which stalks the market is not the recession -- a recessionary outlook would hit risky assets such as shares, but would have far less effect on the government bonds." He said "the vital issue is whether the government can meet its targets for reducing the deficits," referring to the public deficit covering central government, local government and welfare budgets. Deutsche Bank chief economist Gilles Moec said that the deficit reduction target "is credible for the time being and the market is taking the government at its word." He argued: "So the risk is not that short-term interest rates will begin shooting up but rather a slow rise next year if it is seen that the target of 3.0 percent cannot be met because the forecast of growth of 0.8 percent for 2013 will not materialise." Ducrozet observed: "Even if growth is less than expected, there is little risk that the government will go back on its budget targets. The case of Rajoy (the Spanish prime minister) will serve as an example." In December of 2011, Mariano Rajoy, who had only recently been elected to power, increased sharply the target for the public deficit and in doing so destabilised the confidence of investors. The European Central Bank came to the rescue announcing its first long-term refinancing operation, which had the effect of preventing the borrowing rates on bonds issued by Spain, the fourth-biggest economy in the eurozone, from shooting up again to unsustainable levels and staying there. France must also accompany its intentions to bring down the public deficit and subsequently the debt, by presenting a programme for long-term structural reforms. "The government is sending a message with talk of a 'competitiveness shock' and of opening up the labour market. It has to begin turning words into actions," Moec stressed. In this context, "disagreement within the governing Socialist majority or a marked split between the government and trades unions" would be a bad sign, he said.