France macroeconomic and insolvency update: A sputtering economy, anemic investment, record business insolvencies

2014 projected GDP growth between 0.6% and 0.8%, depending on investment levels (+0.2% to +0.6%) A modest 0.4% acceleration in household consumption on an annualized basis A purely mechanical recovery in exports, with €18 billion in additional demand for French exports A slight -1% decline in insolvencies in 2014, but high levels remain (61,800), at a cost to annual growth of 0.22% ​
Euler Hermes outlined its latest French macroeconomic and business insolvency forecast, and assessment of risks weighing on companies in its latest report “When investment is good, all is well … but what happens when it’s not?”
The credit insurer’s report questions whether it is appropriate to discuss a rebound in France after surprisingly strong second quarter growth (+ 0.5% q/q) following two quarters of contraction (-0.2% q/q.) The company’s report proposed two potential 2014 GDP growth forecasts.
 “In our central scenario, growth would remain at 0.6%, supported by a purely mechanical recovery in investment spending,” explained Ludovic Subran, chief economist at Euler Hermes. “In the second scenario, investment spending would be unexpectedly higher and produce 0.8% GDP growth, thereby adding 0.2% to growth.”

2014: Solidifying the pleasant surprise in the second quarter

Resilient consumption in 2014 (+0.4%) … but remains threatened
After rising by a modest 0.3% in 2013, personal consumption is expected to demonstrate continued resilience and accelerate only slightly to 0.4% in 2014. The consumer confidence index is trending upward, but retail sales remain below the long-term trend. Further gains for this driver of French economic growth will be constrained by
  • the tax shocks that continue to weigh on consumer spending: tax bracket creep caused by the elimination of an inflation adjustment, and a VAT increase. Their impact is estimated to reduce household consumption by 0.2% points in 2013.
  • the outlook for higher yields on financial assets (with a forecast of higher interest rates, 10-year French government bonds would approach the 3% threshold), which would result in the savings rate rising from 15.6% in 2013 to 16% in 2014.

A new boost to French exports: €18 billion in additional demand in 2014


Exports are expected to record renewed growth in 2014, rising by 1.9% compared to a 1% increase in 2013, caused by the end of the recession (+0.9%  growth in 2014 vs. -0.5% in 2013) in the euro zone which accounts for 60% of French exports.
 “New export markets will contribute to an additional €18 billion of additional demand for French exports - a 3.9% increase relative to 2013,” noted Nicolas Delzant, chairman of the board of management of Euler Hermes France.
The trade deficit would therefore contract slightly from €70 billion in 2013 to €67 billion in 2014. Beyond the euro zone, export growth will be limited. A tighter U.S. monetary policy would weaken the euro to below US$ 1.30, but cause growth in emerging markets to slow from 4.7% growth in 2014 - a downward revision of 0.5% -  which in turn would weigh on demand. Also noteworthy is the structural composition of these exports, as the increase in export values is expected to be in line with or slightly below the increase in volume.

A shift in the levers to adjust public sector deficit

Euler Hermes is forecasting a French budget deficit equivalent to 3.8% of GDP in 2014, compared with 4.1% in 2013. Although 80% of the 2014 efforts to lower the deficit will focus on public spending reductions, tax increases have changed the tax landscape for businesses and households. Attempts to bring the deficit down to 3% of GDP in 2015 are likely to require further tax increases.
“The adjustment in 2014 will be insufficient due to the limited capacity to cut public spending and, to a lesser extent, to less favorable borrowing costs,” says  Subran. “The government’s main lever for lowering the deficit ratio consists of achieving a higher return on investments in growth, based on measures aimed at stimulating investment.”

Investment, the key to economic recovery

Euler Hermes forecasts two 2014 scenarios for investment. In each case investment will remain the last growth driver to tick upward but would at least finally return to positive territory.

A purely mechanical recovery in investment, resulting in sluggish 0.6% growth

In its central scenario, the “mechanical” turnaround in investment in 2014 (+0.2% compared to a 2.4% drop in 2013) would result in only 0.6% GDP growth when combined with gains achieved in 2013, stabilization of consumption and resumption of exports.
With a growth rate of only 0.4%, corporate investment has been missing in action since 2010. Industrial production, at its lowest level since 1995, confirms this lack of dynamism. According to the French National Institute for Statistics and Economic Studies (INSEE), business leaders expect their investment spending to contract by 6% in 2013 vs. 2102 - a downward revision of 2% - even though credit terms were favorable in 2013 and could tighten in 2014 as a result of rising rates and the accompanying increase in the cost of credit.
The slight 1% drop in the insolvency trend projected for 2014 will underpin a modest rebound in overall investment spending. The marginal decline in insolvencies nevertheless masks record volume levels, with 61,800 companies defaulting in 2014. In 2014, insolvencies will negatively affect GDP growth by 0.22% and destroy 165,000 jobs, i.e., adding 0.5% to unemployment figures.
“The insolvencies increase was spread across the entire economy, particularly affecting small- and medium-sized (SME) businesses,” said Nicolas Delzant. “Our estimates indicate that 1% GDP growth is needed before insolvencies will reduce significantly.”

And if investments are unexpectedly strong? The fragile implementation of a virtuous circle

In 2012 and 2013, France barely avoided a recession, due in part to proactive public policies aimed at stimulating consumption and investment. Implementing a toolbox of investment measures set France apart from its neighbors. According to Euler Hermes’ projections, French economic growth could reach 0.8% in 2014, with investment growth of 0.6% and private sector investment slightly above 1%, if these measures prove effective.
The credit framework established by the creation of Bank for Public Investment (BPI) and the authorization of insurance companies to finance companies directly up to 5% of their balance sheets will undoubtedly result in new sources of investment financing. However a measurable impact is not expected, given the complex implementation processes.
“Nonetheless, the potential impact of the Competitiveness and Employment Tax Credit (CICE) - at 0.2% of additional profit margins - could boost investment growth by 0.2 %,” said Ludovic Subran. “Combined with the research tax credit (CIR) and the €12 billion government-sponsored “Investments in the Future” program, these measures could triple annual investment growth.”
France’s proposed 1.15% tax on gross operating income, which would generate €2.5 billion in revenues for the State, could nevertheless jeopardize this favorable outlook by creating an investment disincentive. Among the biggest losers in the transition from the minimum annual corporation tax to a tax on gross operating income are medium-sized manufacturing companies, who are at the forefront of any economic recovery and represent the third-largest sector contributing to national gross operating income. Their willingness to invest and their access to finance is certainly driven by demand but also largely by the tax framework.
The issue of insufficient investment is not unique to France. Germany underperformed in 2013 and also finds itself with shortfalls in corporate investment. A German tax advantage more favorable by 20 percentage points, plus a debt level 20 points lower and an environment more conducive to foreign direct investment  - €50 billion difference in 2012 - could nevertheless deliver a blow to France’s virtuous investment cycle, especially if a targeted support policy were implemented. France therefore has a narrow window of opportunity.