Higher interest rates will likely crimp the ability of companies in France and Spain to close their competitive gap with Germany, says Standard & Poor’s latest forecast for Europe. Titled “European Economic Forecast: Rising Bond Yields Signal A New Stage In The Cycle,” the report finds that the corporate sectors in France and Spain are more vulnerable to higher short- and long-term interest rates than those in the U.K. and Germany.
“Data from the European Central Bank and Eurostat on nonfinancial corporations reveal that there was a significant financing gap–that is, the difference between the sum of earnings and depreciation on the one hand, and investment spending on the other–of 4% and 10% of GDP, respectively, in France and Spain in 2006,” said Jean-Michel Six, Standard & Poor’s chief economist for Europe. “In the U.K. and Germany, by contrast, there were surpluses of around 1% of nominal GDP.”
As the report points out, these diverging trends are not necessarily due to French and Spanish companies investing more than their U.K. and German counterparts. In France, investment and GDP growth has been lagging that of Germany for the past two years. And although investment has been booming in Spain over the past five years, the ECB’s data shows that that surge has been associated with a dramatic increase in corporate debt outstanding. Spain’s corporate debt reached 106.5% of GDP in 2006–the highest level in the Eurozone, where the average is about 70% and that of Germany 62.2%. In France, meanwhile, corporate profit margins have declined as a share of GDP, while they have significantly increased in Germany and in the U.K. The gross operating surplus of nonfinancial companies in France dropped to 29% of gross value-added last year, while it exceeded 40% in Germany.
“The net result is that French and Spanish companies appear more vulnerable to higher short- and long-term interest rates than U.K. and German firms, whose financing surpluses make them more immune to higher financing costs,” added Mr. Six. “The risk, therefore, is that the competitive gap between Germany on one side, and France and Spain on the other, will widen further instead of narrowing. This gap, as measured by these countries’ relative export performance, and the correlated trends in their current accounts, could expand as corporate investment growth slows in the next 18 months in France and Spain.”
