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Will France be the next market downgrade?

As most of you have seen in recent days, world stock markets have been manic depressive, going through ups and mostly downs due in large part to widespread worries that the US debt downgrade from S&P and the fiscal debt in countries such as Greece, Italy, and Spain will result in worse market conditions for investors.

My other sovereign’s an AAA (The Economist)

There was a market backlash against French debt and enormous market losses for French banks like Société Générale, BNP Paribas and Crédit Agricole (exposed to Greek debt and other European sovereign debt) that is making investors increasingly anxious about France’s debt. Indeed as The Economist writes:

“France’s debt stood at 82% of GDP last year, from 64% in 2007. This is one of the highest of any AAA-rated country. That, investors fear, means it could be the next target for a downgrade, especially if already anaemic economic growth falters further. The extra yield required by investors to hold French debt instead of German Bunds jumped to almost triple the average level of 2010 while the cost of insuring against a default by France reached new highs during the week.”

Moreover, as The Telegraph writes, “French banks have €410bn (£360bn) of exposure to Italy alone according to the Bank for International Settlements. The twin crises in France and Italy are now intimately linked and appear to be feeding on each other.”

How will France proceed? According to a great, in-depth Bloomberg interview (embedding not allowed) with Philippe D’Arvisenet, global chief economist at BNP Paribas SA, France initiating austerity measures is “inescapable”. They go on to discuss France’s exposure to European sovereign debt, reform plans to cut spending but keep tax rates at current levels (though with elimination of some 500 tax loopholes).

The same Telegraph article states, “French president Nicolas Sarkozy has ordered a “general mobilization” to slash France’s budget deficit in a frantic effort to safeguard the country’s AAA rating and head off a downgrade by Standard & Poor’s.”

We will see how this plays out…for now, the markets will likely continue to be manic depressive. Hang on tight!

I leave you with this passage from the Telegraph article:

“…Marchel Alexandrivich from Jefferies Fixed Income said investors are worried that the latest contagion to France could bring the eurozone’s bubbling problems to a head in a dramatic fashion.

“If France is dragged into the problem, then we will hit crisis point. They will either have to move to a full-blown eurobond — and German politicians are set against that — or face a break-up. There is a significant chance that the euro will no longer exist in its current form within twelve months,” he said.
President Sarkozy said France would include a “golden rule” in its constitution to restore fiscal probity, adding that the fiscal targets for 2011 and 2012 were “untouchable”.

The new budget measures will be introduced on August 24 and are expected to include the closure of 500 tax loopholes.

The IMF said France has the highest debt ratio of any AAA state this year at 85pc of GDP and may have to tighten further next year. Like the US, France has also built up huge pension debt and contingent liabilities.”

France to eliminate tax cap, reform wealth tax

France is unfortunately known for its high taxes. One of the recent fiscal measures, le bouclier fiscal or the tax cap (a.k.a. tax shield) limited all direct income taxes to 50% no matter the income bracket. I wrote about this recently on Bonjour Paris. Those who defended it said it lightened the load of taxes, but those opposed to it reckoned it protected the wealthy while not contributing to reducing the deficit and debt.

Recent debate lead up to today’s decision, announced today by Prime Minister François Fillon, to end the policy. (However, some sort of tax cap will remain in place, at an unspecified percentage, for the less well-off, which make up 52% of the beneficiaries). You can see the French article from Le Point at the link above, and the video from BFM TV below.

Below the video, excerpts from this Wall Street Journal article. Next on the agenda: reforming or abolishing the wealth tax (see more in WSJ and Bonjour Paris articles as well as a detailed report by Le Figaro), which could help as many as 300,000 households pay less tax.

What are your thoughts on these developments?

EUROPE BUSINESS NEWSMARCH 3, 2011, 7:38 A.M. ET
French Prime Minister Says Tax Shield to be Abolished

By WILLIAM HOROBIN

PARIS—French Prime Minister François Fillon Thursday confirmed the government intends to abolish a tax shield that has become a controversial hallmark of Nicolas Sarkozy’s presidency.

Mr. Sarkozy decreased the threshold of the tax shield shortly after coming to power in 2007 so that no taxpayer pays more than half their income in taxes. But his ratings have hit record lows and the tax shield has become a thorn in his side as many voters see it as a measure benefiting the wealthy few.

“We have to face up to reality: the tax shield has been misunderstood, and the crisis has probably made our citizens more sensitive to some of its effects,” Mr. Fillon told a conference, organized to discuss the reform of property and capital taxes that Mr. Sarkozy has promised for the first half of 2011.

The tax shield was designed in part to limit the impact of France’s wealth tax, which Mr. Sarkozy also intends to reform before the presidential elections in May 2012.

The government says it will either do away with the wealth tax completely or significantly modify it. Mr. Fillon said Thursday said the reform will free 300,000 households from the wealth tax.

Yet the government is insisting the reform must have a neutral impact on public finances at a time when France is fighting to rein in deficits. If the wealth tax and the tax shield are abolished, the government will need around €3.2 billion ($4.44 billion) to make up the shortfall.

“We won’t finance this reform with debt. Balancing the budget will be strictly respected,” Mr. Fillon said.

He also ruled out a variety of options that have been suggested in recent months. The government will not tax gains on the sale of main residences, will not reverse its reduction of inheritance tax, and will not introduce an additional tax bracket, Mr. Fillon said.

Mr. Fillon also said the reform of capital and property tax is one of the reforms necessary for greater tax convergence in the euro zone.

European leaders are negotiating a competitiveness pact for members of the euro zone. Some countries have balked at Franco-German proposals that they fear would compromise their sovereignty in sensitive areas like pensions and salaries.

Mr. Fillon said France and Germany should aim to harmonize corporate taxes, starting with the base of these taxes before looking at the rates.

Eurozone crisis in graphics

BBC has a fantastic guide to an otherwise discouraging subject: the debt and deficit levels in the Eurozone. As you can see, France’s national debt is at 77.6% of GDP, and its deficit is 7.5%, which makes it about the middle of the Eurozone and enough for major concern.

One of the main causes of the currency crisis in the eurozone is that virtually all countries involved have breached their own self-imposed rules.

Under the convergence criteria adopted as part of economic and monetary union, government debt must not exceed 60% of GDP at the end of the fiscal year. Likewise, the annual government deficit must not exceed 3% of GDP. However, as the maps show, only two of the 16 eurozone countries – Luxembourg and Finland – have managed to stick to both rules.

Overall, Greece is the worst offender, with debt at 115.1% of GDP and a deficit of 13.6% of GDP. But among the bigger economies, Italy’s debt is even higher than Greece’s as a percentage of GDP, while Spain’s deficit is 11.2% of GDP. If the UK were in the eurozone, it would also fall foul of the criteria, with its debt now standing at 68.1% of GDP and its deficit at 11.5% of GDP.

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