Flash Note France: politics

Transcription

1 FLASH NOTE Flash Note France: politics Are French reforms for real? Pictet Wealth Management - Asset Allocation & Macro Research 11 October 2017 The first major piece of President Emmanuel Macron s agenda, the business friendly labour market reform, was signed into law last month. The government has been successful in limiting trade unions opposition, which bodes well for future reforms. The next steps include further structural reforms and tax cuts. Some measures may have adverse effects in the short-term, some others are not fully financed and difficult to quantify, but overall they should boost purchasing power, investment and productivity. Our cautiously positive assessment suggests that France s potential growth could gradually increase towards 1.5%. Reform momentum is also important for rebuilding trust and confidence with France s European partners. We see more common ground between Macron and Merkel that is generally acknowledged. A fully-fledged fiscal union may not be feasible (nor desirable), but any concrete steps towards greater integration should be welcomed by markets, including a roadmap to a euro area fiscal capacity and finance minister. AUTHOR Frederik DUCROZET fducrozet@pictet.com Pictet Group Route des Acacias 60 CH Geneva 73 This year's developments in French politics have been highly unusual by French standards, to say the least. The young leader of a new centrist party was elected president on a pro-business, pro-reform, pro-european platform, beating the eurosceptic far-right candidate and generating an unprecedented wave of enthusiasm and hope at home and abroad. As a result, the socialist and conservative parties have been left all but clinically dead. A few months later, Emmanuel Macron's popularity had collapsed like few of his predecessors, at the same time as his government delivered on a major campaign promise, the labour market reform, and the economic recovery was strengthening. There seems to be no straightforward explanation for Macron s nosediving public support. A few sensitive topics were arguably mishandled during the summer, including minor budget trade-offs (leading to a cut in social housing subsidies) and a clash with a military chief (leading to his dismissal). More fundamentally, the larger-than-usual slide in opinion polls may reflect a more volatile electorate moving back from the centre to a classic left-right opposition. This natural shift may have been amplified by moves on the sensitive issues of labour market and education. Since then, opinion polls have improved slightly. More importantly, a majority of the population seems to back Macron s reform agenda. The several demonstrations organised to protest against the labour reform have resulted in much lower turnouts than expected. Reforms are off to a promising start the question is whether this heralds the beginning of a new era of profound economic changes. We remain cautiously optimistic. Chart 1: French presidents early approval ratings Approval rating (%) 62 Sarkozy Hollande Macron May June July August September Source: Pictet WM AA&MR, Ifop 45

2 Economic and reform momentum trumps Macron s popularity The president s low popularity matters insofar as it could reduce his appetite for reforms in the future. Already, the government is said to be shifting towards a more social-friendly stance. But, at this early stage of Macron s mandate, lower public support is likely to reflect his willingness to push ahead with painful structural reforms, providing a test of his determination. The strategy could yet pay off eventually, as a majority of the population favours the difficult changes. Importantly, Macron s agenda is still perceived as consistent with his election promises and this should not be understated: the French president made it clear that he intended to say what he does, and do what he said. In our view, two consequences of Macron's reform agenda are far more important than the short-term impact on public opinion. One is to do with broader confidence and tax cuts, the other with Germany and Europe. On the former, the labour market reform has faced the usual criticism, but the government s approach changed. Negotiations during the summer led to a split among the trade unions. Most of them expressed disagreements with the final draft, but only a few joined the latest street protests. In a stunning deviation from 50 years of systematic opposition, the leader of one of France's powerful unions, Force Ouvrière, said that although he disagreed with the reform, the government had listened to his requests and agreed on some concessions, so that all the actors should "assume their responsibilities". This may also help with more constructive social dialogue in the future. In substance, the labour market reform was perceived as business-friendly with only limited dilution compared with previous drafts. The law was articulated around two key principles: decentralisation of labour negotiations and flexibility enhancement of the hiring and firing process, with a special focus on SMEs. Concrete changes will include the introduction of a cap on unfair dismissal compensation; the change in the benchmark for collective redundancy plans whereby firms will be able to justify dismissals based on domestic economic conditions, not at the (international) group level; the decentralisation of certain negotiation topics to the firm level; a comprehensive overhaul of employee representation, unions and training; the introduction of long-term temporary contracts. The main risk is that some of the measures will have an adverse effect on employment in the short-term, as companies may use the window of opportunity to reduce their payrolls. But the hope will be that the French labour market, which is characterised by a high degree of dualism (benefiting insiders relative to outsiders) and an excess of nation-wide labour agreements negotiated by under-represented trade unions, becomes more fluid. This would reduce the legal and administrative barriers to hiring, and eventually boost employment. The second major announcement came with tax cuts, a crucial development for markets. Pending on a broader budget agreement, the campaign promises have been reaffirmed, with a first objective to lower the corporate tax rate from 33.3% currently to about 28% for SMEs (companies with profits of less than EUR500,000), then to 31% for larger enterprises in 2019, and finally to a common rate of 25% by October 2017 FLASH NOTE France: politics PAGE 2

3 Finally, for households, a flat tax of 30% on financial income is planned as soon as next year (down from around 45% on average), resulting in a significant tax break on wealth along with a reform of the solidarity tax on wealth (ISF). The latter would include a change in the basis for calculating the tax rate excluding financial assets and focusing on real estate. Chart 2: Corporate income taxes Effective corporate income tax rate including local tax (%) US France (2017) Belgium Germany Portugal Greece Italy Luxembourg Austria NL Spain France (2022) Switzerland Finland UK Ireland Source: Pictet WM AA&MR, OECD A promising start, but further difficulties lie ahead The next steps will likely prove more difficult though. The 2018 budget will involve further trade-offs. Notwithstanding a stronger cyclical recovery and rising fiscal revenues, spending cuts are always going to be tough to agree. As long as the government wants to comply with the EU s 3% deficit target, which it seems dedicated to, the risk is that the limited fiscal room for manoeuvre prevents tax cuts to the extent announced initially. In order to finance the tax cuts, EUR20bn in savings need to be found as a first step for In the transition to the final tax regime, the finance minister said that existing payroll tax credits (CICE) would be transformed into a permanent cut in employers contributions by The next key structural reforms on the agenda are unemployment benefits (reducing incentives to stay unemployed while shifting the management from social partners to the state) and the pension system (unifying dozens of existing systems). If the labour code was a sensitive issue, those two are likely to prove even more explosive. Whether the government can address them comprehensively will depend on how much political capital it has left. Our impression is that the reform of the unemployment benefits system is the most at risk of being watered down. Meanwhile we expect a greater focus on other measures related to professional training, competitiveness and possible some modest, targeted fiscal easing as a compensation. Looking ahead, Macron does not face any major elections before the EU parliamentary polls in If everything goes according to plan, the economy will have improved further by then, unemployment will have fallen, and some reforms may start to bear fruit. By then, the president knows that he will have to reconnect with a large electoral base if he wants to push even further with his ambitious agenda. 11 October 2017 FLASH NOTE France: politics PAGE 3

4 Banking on a boost to potential growth If all those measures are implemented in full, French attractiveness as an investment destination could get a very welcome boost over the mediumterm, supporting potential growth. Confidence has been scarce in French business circles for the past few decades. It would be illusory to try and quantify all current and future reforms at this stage, not least because important details are missing in order to estimate spillover effects. The hope, as usual in these cases, will be that most reforms can pay for themselves over the long run. Several institutions have provided early simulations to be treated with caution. For instance, the French Think Tank Coe-Rexecode published their estimates of the macroeconomic effects of Macron s programme before the elections, which we reproduce in Chart 3 below. Even a half-delivery would help lift GDP growth by about 0.4 percentage point in the first two years, although the institute assumed that the constraints on spending cuts would then force significant budget adjustments to meet France s deficit targets. Chart 3: Various estimates of the effects of Macron s measures on GDP growth Extra annual GDP growth relative to baseline (%) 1.4 Full delivery (maximum impact) Full delivery (smoothed impact) Half delivery Source: Pictet WM AA&MR, Coe-Rexecode Against the backdrop of very favourable business conditions, our broader assessment remains cautiously optimistic. For example, if the corporate tax cuts are implemented in full, several studies suggest that they could be a game-changer for the French economy, pushing up GDP growth by at least 0.5% over the longer-term. In its latest forecasts, the European Commission put France s potential growth rate at % in 2018 compared with 1.5% for Germany. Structural factors including demographics suggest that France is likely to outperform Germany eventually, and Macronomics may well accelerate the catch-up process. Macron s ambitious European agenda faces headwinds On Europe, the outcome of the German election will likely complicate Emmanuel Macron s task in pushing for ambitious governance reforms, assuming that the liberal FDP party will be part of a coalition government in Germany. However, as we argued after the German election, rather than a quantum leap in terms of integration, Macron s strategy has so far consisted of politically ambitious yet acceptable propositions, including a euro area 11 October 2017 FLASH NOTE France: politics PAGE 4

5 dedicated budget and investment plan, but ruling out debt mutualisation and larger transfers. We see more common ground than is usually acknowledged with Angela Merkel and Wolfgang Schäuble, who will become the president of the German parliament. Meanwhile Macron has focused on restoring confidence and trust with his German partner. The labour market reform project was very positively received in Berlin. Notice: This marketing communication is not intended for persons who are citizens of, domiciled or resident in, or entities registered in a country or a jurisdiction in which its distribution, publication, provision or use would violate current laws and regulations. The information, data and analysis furnished in this document are disclosed for information purposes only. They do not amount to any type of recommendation, either general or tailored to the personal circumstances of any person. Unless specifically stated otherwise, all price information is indicative only. 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Copyright Banque Pictet & Cie SA is established in Switzerland, exclusively licensed under Swiss Law and therefore subject to the supervision of the Swiss Financial Market Supervisory Authority (FINMA). Distributors: Banque Pictet & Cie SA, Pictet & Cie (Europe) SA Whether a euro area fiscal and political union is feasible or desirable is open to debate. Germany is unlikely to agree on a large enough fiscal capacity without strong conditionality. And even in the best-case scenario, a new institutional set-up will take time to materialise, let alone a Treaty change if necessary, leaving countries like Italy vulnerable to shocks. Still, any concrete steps towards greater financial, economic and political integration should be welcomed, and so will a closer, more efficient Franco-German duo. Equity market impact of the French tax reform The planned 2018 tax rate reduction for SMEs will not impact French listed companies. However, the proposed tax rates of 31% in 2019 and 29% in 2020 for larger companies will lift the CAC s underlying earnings growth outlook, from a current 2019 estimate of +8.6% to +12.5% and from a 2020 estimate of +7% to +8.9% according to our calculations. While the effect is not massive, it is sufficient to provide the CAC with the highest underlying profit growth outlook compared to other European markets. At the Stoxx Europe 600 level, the proposed French tax reduction s impact on total earnings growth will be strongly diluted, but nevertheless positive. The effect should be greatest in 2019, with expected earnings growth rising from +8.7% to +9.5%. In terms of valuations, the CAC is somewhat cheaper than the Stoxx Europe 600, but the gap varies according to valuation ratios. It amounts to about 5% with 12M forward price/earnings, 7.5% with 12M forward EV/EBIT, 18% with 12M forward price/book (see chart hereunder) and 14% with 12M forward ROE. Chart 2: Relative 12M forward price/book discount (CAC vs. the Stoxx Europe 600) Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Source: Pictet WM AA&MR, Factset While valuation gaps have evolved in tight ranges for five years, positive profit surprises could cause them to reach their upper limits or even exceed them, especially as the tax reform is likely to last until October 2017 FLASH NOTE France: politics PAGE 5