What is France to do?

November 14, 2013

It’s euro zone third quarter GDP day and Germany and France are already out of the traps with the latter’s economy contracting by 0.1 percent, snuffing out a 0.5 percent rebound in the second quarter. Growth of 0.1 percent was forecast, not just by bank economists but by the Bank of France too.

Germany failed to match its strong 0.7 percent growth in the second quarter, but expanding by 0.3 percent – in line with forecasts – it is clearly in much better shape.

The Bank of France has estimated stronger growth of 0.4 percent in the final three months of the year but the euro zone’s second largest economy is a growing cause for concern. An OECD report on French competitiveness, released overnight, said it is falling behind southern European countries that have bitten the reform bullet.

The OECD warned that markets can turn quickly on vulnerable countries although with its deep and liquid bond market, France is somewhat protected in that respect. France’s labour and pension reforms are widely viewed as being timid and with Hollande’s poll ratings at record lows there is not much chance of a great leap forward.

Spain has been much more aggressive and is seeing the benefits in terms of rising exports (and, admittedly, sky-high unemployment). So too has Portugal.

Madrid has already reported an exit from nine quarters of contraction with growth of just 0.1 percent. And a senior Italian official told Reuters this week that the euro zone’s third largest economy probably contracted by 0.1 or 0.2 percent in Q3 but would return to growth in the last three months of the year.

Growth across the currency bloc is forecast at a tepid 0.2 percent, just down from Q2’s 0.3 percent and with unemployment sky high in many countries, talk of recovery rings hollow.

Later in the day, euro zone finance ministers meet in Brussels.

With Ireland nearing its exit from a bailout programme, discussion about whether it should take a precautionary credit line to tide it over is likely. The latest noises from Dublin is that it may not given it is funded into 2015. ECB chief Mario Draghi has signalled that it probably should.

With the troika of inspectors in Greece, it bailout progress will be on the agenda as will Portugal’s. Latest reports suggest the troika and Athens are still at odds over how to fill a 2 billion euros hole in the 2014 budget.

Banking union is a perennial point at issue but with German coalition talks likely to drag on well into December no big decisions will be taken yet.

As we exclusively reported over the weekend, Angela Merkel’s Conservatives and the centre-left SPD have agreed as part of coalition negotiations that a key part of European banking union – a body to decide when to rescue or close failing banks – should be attached to the EU finance ministers group, not the European Commission. This could open the way for agreement at EU level by the year-end but there are downsides.

Giving the Ecofin (which meets on Friday) the right to rule on the fate of a struggling banks clearly raises the risk of politicizing the issue and of splits within the council. Furthermore, the CDU and SPD have rejected any common fiscal backstop for euro zone banks for the foreseeable future so governments will be liable for cleaning up their own banks if they have to be wound up.

Only as a last resort could a country unable to bear the cost apply for a loan from the European Stability Mechanism rescue fund, but that would add to its national debt. Much further down the line, the plan is for a common resolution fund to be financed by the banks themselves.

The German plan has not yet been signed off by the people who really count in Berlin so it’s not clear if Finance Minister Wolfgang Schaeuble will be have a proposal to present today and tomorrow. But it would be surprising if it wasn’t discussed at some level.

Meanwhile, the centre-left Social Democrats (SPD) meet in Leipzig from Thursday to Saturday for a party congress where leader Sigmar Gabriel will rally support for an impending coalition deal. He has to convince delegates who in turn must persuade grassroots supporters to approve the eventual accord in a vote. The SPD is keener on common euro zone structures than the CDU but is not making a big issue of it, focusing instead on domestic issues like a national minimum wage.

Slovenia’s government, which is waiting with trepidation for bank stress tests next month which could determine whether it needs a bailout, faces a confidence vote. An expected ‘Yes’ vote will shore up political backing for Prime Minister Alenka Bratusek’s disparate ruling alliance but that is the least of its problems.

With largely state-owned banks beset with nearly 8 billion euros of bad debts – equivalent to nearly a quarter of the entire economy – the government’s insistence that it can put them right alone is very much open to doubt. The good news is that a Slovenian bailout won’t break the euro zone bank. The bad news is that it would be politically very tricky.

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