The cost to insure French debt soared this week as traders started to shift their attention away from the economic health of Europe's more profligate periphery to that of its core members. France has been scrambling for months to come up with a plan to save its coveted triple-A credit rating and convince the markets that it is in fine economic shape. While the country is better off than Italy, it is certainly not as healthy as its perfect credit rating suggest. France knows what it needs to do to get its fiscal house in order, but it risks facing an Italian-like crisis to finally bite the bullet.
Italy has dominated the headlines out of Europe this week as its government fell into chaos and its largest bank, Unicredit, reported a record loss. But many traders in New York and Europe seemed more interested in the news coming out of Paris than Rome. On Monday, French Prime Minister Francois Fillon revealed a much anticipated austerity package that was meant to save France's coveted triple-A credit rating and help spur growth.
The market was not impressed. After the announcement, the cost to insure French debt using credit default swaps jumped to a record 236 basis points, according to brokers in the City of London. That meant it would cost as much as 236,000 euros per year for an investor holding 10 million euros of French bonds to protect themselves from a sovereign default. That's a considerable payout on debt that should ostensibly be considered risk free given the nation's perfect triple-A credit rating.
The jump in CDS spreads probably shocked many French politicians who thought that the measures they had proposed were extremely tough. The plan would see corporate tax rates go up by 5%, while the value added tax on services would go up from 5.5% to 7%. It would bring forward by one year the implementation of a controversial plan to raise the retirement age in France from 60 to 62 years old. The plan also eliminated some tax deductions and state assistance.
Fillion said he hoped the plan would bring about 7 billion euros in budget savings in 2012 and a further 11.6 billion euros in savings for 2013. In total, he said the plan would produce 65 billion euros in savings by 2016.
Slower growth, smaller tax base
That might seem like a tough plan, but it looks pretty weak when one drills down a bit. The bulk of the "savings" in the plan come from tax hikes as opposed to cuts in the country's bloated welfare state. Such large tax increases will most likely slow France's already anemic economic growth rate. As the country's growth rate stalls, so will its tax base, negating any possible "savings" it might receive.
