French budget may duck reforms, frustrate markets

By Daniel Flynn, Reuters

PARIS — Investors and governments from Beijing to Berlin regard France’s 2013 budget this month as the acid test of President Francois Hollande’s credibility but those hoping for long-overdue reforms and bold spending cuts are likely to be disappointed. While Italy and Spain have swallowed painful austerity and reformed pensions and labor laws under pressure from bond market vigilantes, the new Socialist government in Paris has so far escaped higher borrowing costs despite raising billions of euros in extra taxes to plug a deficit gap this year.

That may not last.

With Europe’s number-two economy on the brink of recession and public debt nearing 90 percent of gross domestic product, Hollande knows he must convince investors of his deficit-cutting mettle to avoid being dragged deeper into the eurozone crisis. “French debt is significantly overvalued,” John Gilbert, chief investment officer for General Re, a unit of Warren Buffet’s Berkshire Hathaway, warned in August. “We do not know if the markets will turn on France,” he said in a research report, arguing that Paris should be paying 4.5-5.0 percent on 10-year bonds, rather than the current 2.25 percent, based on its fiscal performance.

Hollande’s pledge to set an example of budget responsibility by hitting a deficit target of 3 percent of GDP next year stirred hopes he would at last rein in public spending, second only to Denmark’s in Europe at 56 percent of economic output. Instead, the signs are that the government will fall back on traditional French tactics of basing the budget on overly optimistic growth forecasts and loading yet more taxes on the rich and big firms, while trimming spending only lightly.