Investment Research General Market Conditions Research France France at the crossroads after presidential elections On 23 April 2017 the first round of the French presidential election will be held, with the potential final run-off scheduled for 7 May. The election is expected to be a tight race between François Fillon from the Republicans and Marine Le Pen from the Front National, who are currently leading the polls for the first round. One month after the presidential election, parliamentary elections for the National Assembly will take place (see timeline below). Timeline of the French presidential and parliamentary elections Macron (En marche!) announces presidential bid 16-11-2016 Q3 2016 Republican Primary first round 20-11-2016 Source: Danske Bank Republican Primary run-off 27-11-2016 Q4 Socialist Primary first round 22-01-2017 Today Socialist Primary run-off 29-01-2017 Q1 2017 Presidential National election Assembly second round elections 07-05-2017 first round National 11-06-2017 Presidential election first round 23-04-2017 New President is inaugurated 07-05-2017 + 10d Predicting the election outcome is difficult due to the range of candidates (see below) and the particularities of the French presidential electoral system, with its two stages of voting. In the first round, candidates from all parties participate. Should no candidate be able to reach an absolute majority (more than 50% of the vote this has never happened) in the first round, a second round run-off is held between the two candidates that received the most votes in the first round. To win the presidency, a simple majority (highest number of votes cast) suffices in the run-off. Hence, theoretically, it is possible for a candidate who came second in the first round, to win the presidency by receiving broader support in the second round run-off (and vice versa). As many candidates are running for president, it is unlikely that one of them will receive an absolute majority in the first-round and instead the election will probably be decided by the run-off on 7 May. Q2 Assembly elections second round 18-06-2017 Q3 4 January 2017 Key facts on France Population: 66.8m (2016) GDP per capita: EUR32,800, 8 th highest in the euro area (2015) Government type: Republic Majority coalition led by Socialists (PS) President: François Hollande (PS) Prime Minister: Manuel Valls (PS) Next elections: April 2017 Central bank governor: François Villeroy de Galhau Economic characteristics Relatively low export-to-gdp ratio Large public sector (57% of GDP) High public debt (96.1% of GDP) and large government budget deficit (3.5% in 2015) Large service sector (due to tourism) and chemical industry Inflexible labour market and high unemployment rate (9.7%) AA rating Sources: Danske Bank Overview of the presidential candidates Candidate François Fillon Political party Républicains Radically anti-immigration and euro-sceptic stance Wants France to leave the euro and has promised to a hold referendum on an EU-exit Marine Le Pen Front National Economic policy: protectionism to shield domestic industries from globalisation Bigger role of the state and renationalisation of key areas (energy, transport, health and education) Foreign policy: closer ties to Russia Former investment banker and economy minister Emmanuel Macron Independent Left Hollande's government to start own political movement, En Marche! Centrist candidate aiming to bridge the political Left and Right Built his campaign on defending the EU and advocates closer ties with the rest of Europe Manuel Valls/ Arnaud Montebourg Jean-Luc Mélénchon Socialists Left Front Source: Danske Bank Candidate profile and campaign pledges Has reputation as honest politician and reformer Supporter of Thatcherism and has run with a hard-line liberal reform programme Plans to slash government expenditures by EUR100bn to reduce public debt and balance the budget Plans to cut 500,000 public sector jobs, reduce unemployment benefits, scrap the 35 hour working week and extend the retirement age gradually to 65 from 62-63 Promised tax cuts of EUR50bn, cut corporate tax rate from 33% to 25%, raise VAT rate by 2pp to 22% Social conservative, advocating catholic family values Tough stance on immigration and strict Islam regulation Foreign policy: pro-eu and pro-russian stance Candidate will be determined in the primaries at the end of January 2017 François Hollande announced that he will not stand for re-election, given his low approval ratings due to a poor record on unemployment, national security and immigration Current pro-business prime minister Manuel Valls is now the leading contender Valls will likely face left-wing Arnaud Montebourg, a former economy minister, at Socialist's primaries run-off Former Socialist minister finished fourth in the 2012 presidential election Represents a hard-line left and EU-sceptical stance Senior Analyst Pernille Bomholdt Henneberg +45 45 13 20 21 perni@danskebank.dk First Year Analyst Aila Mihr +45 45 13 78 67 amih@danskebank.dk Assistant Analyst Christian Belling Sørensen chsr@danskebank.dk Important disclosures and certifications are contained from page 9 of this report. www.danskeresearch.com
Given the deep unpopularity of Socialist president François Hollande and his fractured party, it currently seems difficult for any Socialist candidate to reach the second round, as they are polling even behind Macron and Mélénchon at 9%. According to one opinion poll from 27 November, Fillon and Le Pen would currently obtain the most votes in the first round and hence be the favourites to enter the run-off. In this scenario, the poll indicated that Fillon is projected to win against Le Pen comfortably in the second round, with 67% to 33% (see below concerning uncertainty related to opinion polls). Still, it is too early to write off the Socialist party. Since the left-leaning voters are now faced with the alternatives of Le Pen and Fillon, the Socialist party could still gain some momentum, especially if Manuel Valls should emerge as the Socialist s candidate from the primaries and economic releases in Q1 17 surprise on the upside. In many respects, Fillon s reformist image has its advantages, as the Republicans also face a challenge for votes in the centre from the reformist Macron. His tough stance on immigration is also likely to strengthen his chances against Le Pen in a potential runoff next May, because it will appeal to right-wing voters, who might otherwise have voted for Le Pen, should a more centrist Republican candidate such as Juppé have emerged as winner from the Republican primaries. However, with his socially conservative and radically liberal reform programme, Fillon lacks the broad appeal to both voters on the Right and Left and may struggle to unite them against Le Pen in a potential run-off. With hard-line liberal initiatives such as abolishing the 35-hour work week or cutting public sector jobs, Fillon hence risks antagonising exactly the voters he will need to defeat Le Pen. In the past, voters have always united to prevent the far-right from winning the presidency, as happened in the run-off between Jacques Chirac and Jean-Marie Le Pen in 2002. Furthermore, according to data from the European Commission s Eurobarometer survey, the French are not that euro-sceptic. So if Fillon can convince with a viable programme to address unemployment and strict immigration policies, he could still capture votes from the Front National, despite his pro-eu views. However, given the current populist, antiestablishment mood in Europe and the uncertainty around opinion polls, the outcome of the run-off remains unpredictable. The key question will be whether the candidate facing Le Pen in the second round will be able to successfully unite moderate French voters against the far-right, in a country still struggling with high unemployment, a muted economic and fiscal outlook and terrorism threats. Opinion polls showing Fillon in the lead (27 November) % % Presidential election - first round 26 24 14 13 9 6 3 311 0 20 40 60 80 100 Fillon (Republicans) Macron (En marche!) Socialists Jadot (Greens) Presidential election - second round Poutou (Anticapitalist Party) 67 33 Le Pen (Front National) Mélénchon (Left Front) Bayrou (Democratic Movement) Dupont-Aignan (France Arise) Arthaud (Workers' Struggle) Source: Harris Interactive Polls, Danske Bank French are not too euro-sceptic 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Ratio being against the euro as a common currency AT EU IT FR GR 34% 36% 37% FI NL BE PT EA SP 28% 30% DE 20% 22% 23% 23% 25% 25% IE 15% 9% UK SE DK 67% 69% 64% Source: Eurobarometer, European Commission, Danske Bank Overview of presidential election outcomes Presidential election (by universal suffrage in two stages of voting) Front National: Le Pen Socialist candidate Independent: Macron Left Front: Mélénchon Republicans: Fillon First round (absolute majority necessary to win) Deeply unpopular, unlikely to enter run-off Unlikely to get enough votes to enter run-off Second round run-off between two top candidate in first round (simple majority suffices to win) Polls show Fillon winning run-off against Le Pen with 67% against 33% Risks In the past, voters have united to prevent the far-right from winning, but nothing can be ruled out given the current populist, anti-establishment mood in Europe and the uncertainty around opinion polls. With his socially conservative and liberal reform programme, Fillon lacks the broad appeal to both voters on the right and left and might struggle to unite them against Le Pen. Source: Danske Bank 2 4 January 2017 www.danskeresearch.com
What will happen after the presidential election? Ten days after the new president is elected, he or she will be inaugurated. On 11 and 18 June 2017, two rounds of parliamentary (legislative) elections will be held to elect the Deputies for the National Assembly. The National Assembly consists of 577 members and is elected every five years by a similar two round voting system to the presidential election. Should Fillon be able to win the presidency, it is currently the most likely scenario that the Republicans would also receive the most votes in the parliamentary election, allowing the president to start implementing his reform agenda. On the other hand, should the new president come from the Socialists or Front National, there will be a high degree of policy uncertainty, as both parties currently seem unlikely to win a working majority in parliament. In this case, the president and the majority of deputies and thereby the prime minister who is usually chosen from the majority party will come from different political parties. The result would be a weak and fractured government, with opposing legislature and executive and the risk of political gridlock ( cohabitation ). If there is a Le Pen presidency under cohabitation, a potential referendum on EU membership also seems unlikely, since such an initiative would require approval by the Constitutional Court as well as the support of one fifth of MPs and one tenth of the electorate. Overview of potential outcomes after the presidential election Presidential election run-off is won by Le Pen Fillon President is inaugurated Parliamentary elections FN also wins parliament Republicans or Socialists win parliament FN or Socialists win parliament Republicans also win parliament Prime minister chosen from FN party Prime minister chosen from majority party Prime minister chosen from majority party Prime minister chosen from Republican party Government starts implementing FN s programme Source: Danske Bank Cohabitation : political gridlock between parliament and president Government starts implementing Fillon s reform programme and what powers does the future president have? The president is the official head of state and the armed forces, leading negotiations with foreign heads of state and signing treaties. He also has the power to dissolve parliament, nominate the prime minister and the council of ministers and can call referenda on law changes. While in office, the president enjoys immunity from prosecution. Although the parliament has little control over the president s powers as such, it can theoretically repeal him from office, if he is deemed to be failing in his duties. The president can serve a maximum of two consecutive five-year terms. Usually, president and prime minister share the powers of the executive, since they will most likely come from the same political party. If there is cohabitation, the balance of power shifts in favour of the prime minister, since he is considered to command a higher degree of democratic legitimacy in this case, as parliamentary elections take place after presidential elections. 3 4 January 2017 www.danskeresearch.com
In the absence of reforms, the economic outlook is subdued The outcome of the presidential election will also have important implications for the future direction of the French economy, which accounts for about one fifth of euro area GDP. France s real GDP growth has declined from 2.1% in 2011 to 1.3% in 2015 and is projected to remain at modest levels in 2017-18 (see table). Public debt had spiralled to 96.1% of GDP at the end of 2015, and high government spending remains an obstacle to fiscal sustainability, causing public debt to approach triple digits. Medium-term growth prospects are hampered by structural rigidities, especially in the labour market (see right). The unemployment rate, standing at 9.7%, is still significantly above pre-crisis levels and high youth unemployment is a particular concern. Fiscal sustainability and higher private sector job creation remain the key challenges for the French economy in the future, according to the IMF. To stimulate job creation, the OECD recommends the government to reduce the tax burden and cut expenditure. Outlook for key economic variables France GDP (1) CPI (1) Unemployment (2) Govt. Budget (3) Sources: OECD (Oct), IMF (Nov), EU (Nov), Danske Bank Govt. Debt (3) 2017 2018 2017 2018 2017 2018 2017 2018 2017 2018 Danske Bank 1.0 1.2 1.3 1.4 10.0 9.8-2.9-3.1 96.8 97.4 IMF 1.3 1.6 1.0 1.1 9.6 9.3-3.0-2.7 97.8 97.9 OECD 1.3 1.6 1.2 1.2 9.7 9.6-3.0-2.9 99.4 100.2 EU (Commission) 1.4 1.7 1.3 1.4 9.9 9.6-2.9-3.1 96.8 97.1 1) % y/y. 2) % of labour force. 3) % of GDP. But Fillon s proposals would address many of France s economic challenges Should Fillon become the next president, we are likely to see a radical overhaul of the economy and more business friendly policies. Fillon promised to introduce tax cuts of EUR50bn, targeting mostly payroll taxes and cutting the corporate tax rate from currently 33% to 25%. To offset the revenue loss, he plans to increase the VAT rate by 2 percentage points. As a result, French goods would become more competitive abroad, while imports would become relatively more expensive, overall improving France s terms of trade. This would also help rebalancing and diversifying France s growth model from consumption towards more export-led growth, strengthening economic resilience going forward. Fillon s reform proposals to improve the functioning of the labour market, by simplifying firing restrictions, lifting the 35-hour legal cap on the working week, shrinking the labour code to just 150 pages as well as raising the retirement age to 65, would be an important step towards addressing France s labour market rigidities and the high level of structural unemployment which presents a particular social and economic challenge. Although these reforms would raise productivity and potential growth, his proposals to shrink the public sector also risk triggering clashes with labour unions and public-sector workers. Strikes and unrest could hence depress economic output in the short-term after such reforms have been implemented. However, even if public spending could be cut to 49% of GDP by 2022 as envisioned by Fillon (it currently stands at 57% of GDP), it would still lie well above the OECD average of 45% of GDP, highlighting the prominence of the public sector in the economy. Public debt remains high amid modest growth outlook Source: Macrobond Financial, IMF, Danske Bank A long list of labour market rigidities Centralised labour agreements for over 700 sectors Long and uncertain judicial procedures around dismissals Firing restrictions Relatively easy access to unemployment and welfare benefits Relatively high minimum wage Labour code with over 3,000 pages Increasing mismatch between the existing skills of the jobless and those sought by employers Sizeable labour tax wedge Source: IMF, Danske Bank France s terms of trade could improve Source: Macrobond Financial, Danske Bank Public spending is high compared to the European average Source: Macrobond Financial, Danske Bank 4 4 January 2017 www.danskeresearch.com
gross debt % of GDP gross debt % of GDP Research France Fillon s planned tax cuts would likely lead to a higher budget deficit in the short run, since fiscal spending cuts would only be introduced gradually once the economic recovery gathers steam. His programme foresees the deficit ballooning to as much as 4.7% of GDP in 2017, before gradually improving towards zero by 2022 due to a rebound in growth facilitated by lower taxes. This is significantly above the 2.7% target that Paris agreed upon with the European Commission and hence Fillon s fiscal plans risk triggering opposition from Brussels, which has already twice extended the deadline for bringing the deficit below the 3% threshold. Fillon himself has argued that obtaining some fiscal flexibility from Brussels will not be a problem and a recent study from the OECD (Most countries have room to increase public investment, 24 November 2016) seems to support his case, showing that France, like many other European countries, could afford some fiscal relaxation to boost long-term growth, after years of fiscal consolidation. Using a simple debt accounting model to project the future path of public debt under different scenarios, we can see a clear divergence in the debt outlook under a Fillon and Le Pen presidency. Le Pen s economic and fiscal policy plans have so far been very vague, but should she become president and be able to implement some of her campaign pledges, renationalisation and a bigger public sector would likely lead to a significant increase in fiscal spending and the primary deficit. In the absence of structural reforms, growth is likely to stay at current modest levels and the political uncertainty about a potential euro and EUexit would be likely to drive up debt-servicing costs. The result would be public debt on an upward trajectory, reaching 103% of GDP in 2021. On the other hand, under Fillon s fiscal plans, public debt would peak at around 101% of GDP in 2018, while decreasing thereafter to 96% in 2021 as growth picks up due to tax cuts and growth-enhancing structural reforms as well as public spending cuts. Hence, although public debt would increase above the IMF s baseline projections in the short-run due to tax cuts and other structural reforms that weigh on public spending the debt burden would still fall sharply once these reforms take effect. Fillon s economic proposals address many of France s economic challenges, such as reigning in public spending, reducing the size of the public sector and reforming the labour market. Nevertheless, the great uncertainty with his economic programme is, whether he will be able to implement his measures in practice as well. This will to a large extent depend on how many votes his party receives in the parliamentary elections in June 2017, if he becomes the next president. Weaker fiscal outlook with Le Pen could trigger downgrade Although France is currently rated AA/Aa2 with a stable outlook by S&P, Fitch and Moody s, political uncertainty, a weaker fiscal outlook and public debt on an upward trajectory as in the Le Pen scenario, could cause renewed focus on France s sovereign credit rating. As mentioned above, a Le Pen presidency could with high probability result in a cohabitation government. The resulting political gridlock would weigh on financial markets and potentially weaken the growth outlook, making a downgrade a clear risk. Government bond spreads to Germany have already increased in recent months on increased political woes. Ultimately, the size of the financial impact after the elections will depend on the extent of parliamentary support for Le Pen s economic and fiscal policy and on whether Front National would really go through with calling a referendum on leaving the euro/eu. Budget deficit set to widen under Fillon in the short run Source: Macrobond Financial, Danske Bank While Le Pen policies could lead to increasing debt burden 104 102 100 98 96 94 92 90 88 Assumptions: growth decreases to 0.8% in 2017 due to political turmoil and thereafter recovers to 1.3%; primary deficit deteriorates to -1.7% of GDP until 2021; debt servicing cost jumps up by 0.5pp in 2017 due to political uncertainty and then gradually declines. Source: Danske Bank debt trajectory is downward sloping under Fillon 102 100 98 96 94 92 90 88 IMF baseline debt projection Le Pen scenario 2015 2016 2017 2018 2019 2020 2021 IMF baseline debt projection Fillon scenario 2015 2016 2017 2018 2019 2020 2021 Assumptions: growth increases to 1.8% in 2017 and thereafter rises by 0.2pp per year; primary deficit increases to -3.7% of GDP in 2017 and gradually improves to zero by 2022; debt servicing cost jumps up by 0.5pp in 2017 due to higher spending. Source: Danske Bank France sovereign credit ratings S&P: AA Stable Moody s: Aa2 Stable Fitch: AA Stable Source: Thomson Reuters, Danske Bank Government bond spreads are widening Should Fillon emerge as president, we expect to see a positive market reaction. His growthenhancing reforms and government spending cuts could trigger an improvement in the credit rating outlook to positive or even prompt an upgrade to AA+ in the long-term, if public debt is steadily falling. Source: Macrobond Financial, Danske Bank 5 4 January 2017 www.danskeresearch.com
Key macroeconomic indicators French GDP growth has been modest recently GDP growth is set to remain at modest levels in 2017-18 Source: European Commission, Danske Bank Government budget has improved post crisis, but still high Public debt is approaching triple digits Source: European Commission, Danske Bank A big public sector Public revenue has gone up expenditure remains very high Source: European Commission, Eurostat, Danske Bank Unemployment still above pre-crisis levels and youth unemployment is higher than euro area average Source: Eurostat, European Commission Danske Bank Source: European Commission, Danske Bank 6 4 January 2017 www.danskeresearch.com
French labour productivity follows the euro area average when measured per hour but falls slightly behind when looking at per person employed French labour productivity below OECD average France s nominal unit labour costs above euro area average Source: OECD, Danske Bank Private consumption remains the main driver of growth Consumer confidence points to growth in consumption Source: European Commission, Eurostat, Danske Bank Investments have not entered an upward trend Industrial production lags behind euro area average 7 4 January 2017 www.danskeresearch.com
Headline and core inflation remain below 1.0% French output gap is bigger than euro area and not closing Source: OECD, Danske Bank France has a low export-gdp ratio...and a current account deficit Source: European Commission, Eurostat, Danske Bank House prices trended slowly lower no big correction Construction activity indicators have improved recently Source: Macrobond Financial, Danske Bank Source: Markit PMI, Danske Bank Higher yields recently, but still low from a longer perspective Political uncertainty could result in lower credit rating Source: OECD, Danske Bank Source: Fitch, Moody s, S&P, Danske Bank 8 4 January 2017 www.danskeresearch.com
Disclosures This research report has been prepared by Danske Bank, a division of Danske Bank A/S ( Danske Bank ). The authors of this research report are Pernille Bomholdt Henneberg, Senior Analyst, Aila Mihr, First Year Analyst, and Christian Belling Sørensen, Assistant Analyst. Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in the research report accurately reflect the research analyst s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority (UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation Authority are available from Danske Bank on request. The research reports of Danske Bank are prepared in accordance with the recommendations of the Danish Securities Dealers Association. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high-quality research based on research objectivity and independence. These procedures are documented in Danske Bank s research policies. Employees within Danske Bank s Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank s Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Financial models and/or methodology used in this research report Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the authors on request. Risk warning Major risks connected with recommendations or opinions in this research report, including a sensitivity analysis of relevant assumptions, are stated throughout the text. Expected updates None. Date of first publication See the front page of this research report for the date of first publication. General disclaimer This research has been prepared by Danske Bank (a division of Danske Bank A/S). It is provided for informational purposes only. It does not constitute or form part of, and shall under no circumstances be considered as, an offer to sell or a solicitation of an offer to purchase or sell any relevant financial instruments (i.e. financial instruments mentioned herein or other financial instruments of any issuer mentioned herein and/or options, warrants, rights or other interests with respect to any such financial instruments) ( Relevant Financial Instruments ). The research report has been prepared independently and solely on the basis of publicly available information that Danske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliates and subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitation any loss of profits, arising from reliance on this research report. The opinions expressed herein are the opinions of the research analysts responsible for the research report and reflect their judgement as of the date hereof. These opinions are subject to change, and Danske Bank does not undertake to notify any recipient of this research report of any such change nor of any other changes related to the information provided in this research report. This research report is not intended for, and may not be redistributed to, retail customers in the United Kingdom or the United States. This research report is protected by copyright and is intended solely for the designated addressee. It may not be reproduced or distributed, in whole or in part, by any recipient for any purpose without Danske Bank s prior written consent. 9 4 January 2017 www.danskeresearch.com
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