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'France bashing' is not absurd so long as leaders stay focused on tax

'France bashing' is not absurd so long as leaders stay focused on tax

Although the move by Moody's to downgrade France was widely expected, it still came as a blow to the flagging economy and sent the single currency down against the bulk of G10 currencies.

Coming less than a week after France surprised analysts by posting a 0.2% expansion during quarter three, Moody's followed its rival S&P to cut the country's debt rating from Aaa to Aa1- a tier below the top rating.

François Hollande (pictured) will no doubt be waking up to increased pressure to do more to boost growth, with market commentators sceptical about whether the socialist leader's current strategy will pay off.

'We doubt that the French approach, which lacks growth-oriented structural reforms and concentrates on higher direct taxes rather than indirect taxes or spending control, will achieve its deficit reduction goal,' warned Stephanie Kretz, part of the investment strategy team for private banking at Lombard Odier.

Rather than being 'absurd' and 'unfounded' - as France's economic and finance minister Pierre Moscovici put it - Kretz argues that 'bashing' French tactics is deserved as cutting spending would have offered Parisian policy makers a faster route to recovery than tax-focused adjustments.

'Unfortunately, the French budget takes the latter approach,' Kretz added.

While France no longer being held up as the strong arm of Europe may feel like something new, in fact it has failed to balance a budget since 1981, some 31 years, and if imbalances are not addressed it could languish further.

Moreover, French labour costs are also high, exports falling and the two are combining to create a 'substantial loss of combativeness', as warned by Moody's as it issued its single notch downgrade.

The slight reduction in France's 10-year borrowing costs to a record low of 2% and its notes selling at negative yields for the first time in the summer, are both undeniably welcome given the savings for the government.

But these were not enough to convince Moody's, which said it will keep a close eye on contagion migrating from the periphery to Europe's core.

France must do more

Barclays Capital believes that all of these forces will eventually culminate in France taking the necessary actions to get its debt to GDP ratio down from 90%, even if it has so far been slow to get off the starting block.

'The debate about structural reforms is gaining momentum and the government seems ready to step up on different fronts,' the bank's Philippe Gudin said. 

'With plans underway in southern European countries to implement long awaited measures aimed at boosting competitiveness and potential growth, the focus is now shifting to the core,' he added, pointing out that since the beginning of the financial crisis there have been moves to reduce macroeconomic imbalances in a number of euro area countries, even if France has not - so far - followed suit.

Setting these hopes for reform to one side, it cannot be denied that France is lagging behind, Gudin cautioned, pointing out its leaders' slowness to react is largely down to domestic demand holding up fairly well so far.

He said that while growth could feasibly continue through to 2013, it will not last forever if France's politicians maintain this stance.

'The medium- to long-term outlook does not look bright given the structural weaknesses that need to be addressed,' Gudin warned.

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