French slump gives rise to EMU fears

Date: 25/07/1996

By Thomas Klau

THE growing threat of a strong divergence between the economic performances of France and Germany in the run up to the single currency deadline is raising fresh concern among EU officials about the Union's ability to stick to its schedule for monetary integration.

While some economists detect increasing signs of a strong cyclical upswing in Germany, neighbouring France shows little signs of emerging from its slump.

Officials say that if both trends are confirmed in the coming months, the plan to start monetary union on 1 January 1999 - with participating countries to be chosen early in 1998 - might have to be either postponed or pushed through against political and economic odds.

Led by French President Jacques Chirac and German Chancellor Helmut Kohl, senior French and German politicians and central bankers have publicly stated that although the Maastricht Treaty contains no such provision, monetary union would be postponed if either Germany or France were deemed unfit to participate.

Nevertheless, both Bonn and Paris have publicly declared they will make compliance with the treaty's convergence criteria by 1997 their main priority.

The French government's resolve was seriously tested during the country's recent winter of discontent, when a wave of strikes paralysed Paris and challenged Prime Minister Alain Juppé's deficit-cutting programme.

Juppé's ability to ride out the strikes without sacrificing too many of his fiscal measures won praise from financial analysts and soon led to growing market confidence in the ability of both Germany and France to proceed with the single currency as planned.

The new market belief in the likelihood of monetary union, in conjunction with substantial investment flows from French insurance companies, allowed ten-year rates for Paris' debt to achieve near-perfect convergence with German bonds, a move many would have believed unlikely just a few months previously.

But according to analysts, the mood of EMU-optimism still prevailing in the markets might soon come to an end if the latest trends in the German and French economies are confirmed.

Most observers still credit Bonn with the ability to slash its deficit fast enough to push it down to 3.0&percent; by next year, despite the set-back suffered by Kohl last week when the German Bundesrat rejected his government's 26.2-billion-ecu austerity package.

But fears are growing that the French economy's dismal performance might depress fiscal revenue to such an extent that the 1997 budget deficit will remain above the 3.5&percent; considered by some as the absolute maximum for participation in monetary union.

As JP Morgan's senior economist for France David Naude points out, French budget data for the first four months of 1996 was even worse than expected by the most pessimistic observers.

The cumulative effect of less revenue and more slump-related costs is such that analysts now expect the French budget deficit for this year to stay at 4.5&percent;, instead of falling to 4&percent; as planned by Paris.

To make matters worse, the apparent recovery of the German economy is likely to make the economic and political handling of France's weak performance more, rather than less, difficult.

Allowing France membership of a single currency with a budget deficit clearly in excess of 3&percent; would be politically much more awkward if Germany could produce a good budgetary performance.

If the disparity between the two countries' performance is too great, German EMU-sceptics will find it much easier to argue that monetary union would mean replacing the deutschemark with an unsound currency.

This, in turn, might tempt the market into unleashing a fresh wave of speculation against the French franc, which the French central bank would have to fight off with a rise in interest rates.

This is the last thing the anaemic economy, doubly hit by historically-weak consumer confidence and the recessionary impact of the government's austerity programme, currently needs.

After the breathing space they enjoyed in the first half of this year, EMU planners in Paris and Bonn look set for a rocky ride.