DBRS: Macron election will likely bolster France’s creditworthiness

By Thomas R. Torgerson and Fergus J. McCormick

On May 7, France elected Emmanuel Macron of the independent centrist party En Marche! to be President over Marine Le Pen of the far right National Front by a margin of 66.1% to 33.9%.
There are two immediate implications of the election.
The first is that Macron has won a strong mandate to pursue an agenda to reform the labour market, support free trade and strengthen Eurozone integration. If implemented, this agenda would likely reinforce the strengths underpinning DBRS’s rating on France, currently AAA with a Stable trend.
The second is that the defeat of Le Pen reduces uncertainty over the direction of France’s policies and its commitment to the Eurozone. Le Pen had backed protectionist economic policies, restrictions on immigration, pledged to abandon the Euro and hold a referendum on leaving the European Union. Le Pen’s defeat also lowers one of DBRS’s challenges to the rating – that of political risk stemming from anti-EU sentiment.
Since May 2011, DBRS has maintained a AAA rating on France. The strengths of the rating are a high level of productivity and high private savings, a resilient private sector balance sheet, commitment to gradual fiscal consolidation, and the benefits of Eurozone membership. Eurozone membership has provided the public sector with a high degree of financial flexibility, allowing successive governments to implement fiscal adjustment. As a result, government debt-to-GDP is close to stabilising.
Under the Macron administration, DBRS expects broad policy continuity from the Hollande administration. Also likely is some implementation of Macron’s campaign proposals to deepen fiscal adjustment and introduce labour market reforms. During his campaign, Macron ran on a platform of economic policy reforms consistent with European Commission recommendations: increasing investment, pursuing structural reforms, and implementing responsible fiscal policies to boost employment and growth. He pledged to address the structural rigidities that impede private sector job creation, and make public finances more sustainable by increasing the efficiency of public spending.
The factors inhibiting faster employment and output growth are aligned with DBRS’s challenges to France’s rating: weak GDP growth and low inflation have slowed the reduction in the fiscal deficit. Low growth and a high deficit have contributed to high and rising government debt of 96% of GDP. Weak growth is partly the result of the high cost of doing business in France, high and rising structural unemployment, burdensome labour costs, and rigidities in its labour and product markets.

Macron’s policy proposals

Macron’s proposals aim to raise the growth of potential output, which the European Commission estimates reached an average rate of 0.9% from 2009 to 2015, and will pick up to 1.3% by 2018. His proposals also aim to improve social equity and address the social costs of unemployment and other rigidities.
En Marche! has proposed reducing the deficit to below the benchmark 3% of GDP, down from 3.4% of GDP in 2016, while stimulating the economy and labour market through the following initiatives:
1. Raise EUR 50 bln in government investment over five years (2.2% of projected 2017 GDP), to be geared toward worker training programmes and the development of renewable energy.
2. Lower public expenditure by EUR60 billion (2.6% of projected 2017 GDP) over five years:
a. EUR 25 bln from modernizing and reducing the size of the civil service.
b. EUR 10 bln through containing health insurance expenditure to a growth rate of 2.3% per year through better prevention and coverage.
c. EUR 25 bln through a lower unemployment rate of 7% by 2022 (down from 10% in 4Q 2016).
3. Adjust public finances by increasing the efficiency of the state, raising consumers’ purchasing power, improving business conditions, while increasing social protection. This includes shedding 120,000 public sector workers, lowering the corporate tax rate of 33.3% to 25%, and exempting four out of five households from paying the housing tax.
To increase cooperation with Germany and other Eurozone member states, Macron has proposed increasing common investment and introducing a common budget.

A fragmented parliament could impede fiscal consolidation and structural reforms

Macron has also pledged to build cross-party support between the traditional Socialist and Republican parties. However, to achieve its policy objectives, En Marche! will need to achieve sufficient power in the June 11 and 18 parliamentary elections. There are two scenarios for the composition of the new parliament and the ability of En Marche! to carry out its agenda:
(1) En Marche! wins an absolute majority, or at least 290 seats in the 577 seat assembly. This is not impossible. However, En Marche! is a new party without an established political base, and which currently has no seats in the Parliament. A study taken before the second round election showed the party is projected to win 249-286 seats, compared to 200-210 for the Republicans, 28-43 for the Socialists, 15-25 for the National Front, and 6-8 for the Left Front.
(2) En Marche! forms a coalition (la cohabitation) with another party. This would likely be a working coalition in which En Marche! implements some of its agenda, while making concessions to its coalition partner.
Should there be a relaxation of fiscal discipline and a sustained increase in debt-to-GDP as a result of a weak En Marche! government, this could place downward pressure on France’s credit rating.

Fostering social cohesion is also important to Macron’s reformist agenda

Fostering social cohesion and addressing the concerns of those who struggle with low skills and education, face limited job opportunities, or who fear terrorism and immigration will be important to a successful implementation of structural reforms, a safer country and deeper European integration. The election was the first time since 1958 that neither the Socialist nor the Republican Party qualified in the first round of a presidential election. Popular discontent with the policies of the two traditional parties since the Great Recession is evident in the rise of Macron, Le Pen, the far left candidate Jean Luc Mélenchon, and the high percentage of abstentions, at 25.4%. Turnout of 74.6% was the lowest in a second round of a presidential election since 1969.
With the election of Macron, an En Marche!-led government intends to bolster the economic recovery by introducing structural economic changes. However, to avoid social disruption the new administration will need to build a consensus around reforms needed to raise potential GDP growth, improve social equity, and improve the sustainability of public finances. Building consensus around plans to deepen ties with Germany and other Eurozone members will also be important as the Brexit negotiations progress.