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Analysis: Hardest yet to come for France's Hollande on reforms

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[January 23, 2014]  By Mark John and Jean-Baptiste Vey

PARIS (Reuters)  French President Francois Hollande has won cautious backing from Berlin, Brussels and financial markets for a centrist reform push that could be his last chance to get the euro zone's second largest economy motoring.

A week after his January 14 announcement, it is not clear how and when he will pull off the public spending and tax cuts at the heart of the plan. It is also uncertain whether French business will play ball with his goal of cutting unemployment.

Moreover, the new determination to cut taxes opens a whole new Pandora's box: the question of whether Paris will bring its public deficit into line with EU targets next year as promised.

"On the political front, Francois Hollande has pulled off a neat exploit with his 'liberal shift'," said analyst Bruno Cavalier of Paris-based Oddo Securities.

"On the minus side, uncertainty clouds the execution of this policy."

Hollande's change of tack last week came after it became clear his policies thus far were not working: major investment in state-subsidized jobs was not bringing down unemployment, and the public deficit was not falling as quickly as planned despite a string of tax hikes.

In a major shift of emphasis to the supply side, Hollande acknowledged the route to recovery lay in restoring French corporate margins that are the lowest in the euro zone by handing them 30 billion euros of tax breaks by 2017.

Alongside was an announcement that existing plans to trim public spending set to hit 57 percent of national output this year would be accelerated with cuts set to total over 50 billion euros between 2015 and 2017.

Since then, his aides have raced to fill in the gaps. The bulk of the tax breaks are to come from the conversion of tax credits already announced, while the rest will be financed out of 5-10 billion euros in new savings from cutting expenditure. Taxes could start falling as early as next year.

"We won't be able to do much then, but we have got to get the momentum going," said one Hollande aide.


But if France decides on tax cuts as early as next year, that raises the question of whether it will still be able to bring its deficit down from 4.1 percent of output last year to under the three percent threshold it promised for 2015, and then go on to achieve a structural balance in 2017.

Finance Minister Pierre Moscovici told parliament on Wednesday the 2015 target would be met.

But the wager now mooted by some in Hollande's entourage is that a slower pace of deficit-cutting will be accepted by France's EU partners if it is clear that the tax cuts are being used to improve the overall competitiveness of its economy.

"You must never give up hope of being able to convince people with intelligent arguments," said the aide.

The exact pace of any fiscal easing will depend on how quickly economic growth picks up from the sickly 0.9 percent forecast for this year.

The bigger question is whether Hollande will pull off the promised spending cuts at all, while making the cost of labor tangibly cheaper.

Signalling an assault on the costly and complex system of local French government  known as the "millefeuille" after a multi-layered puff pastry  Hollande proposed slimming down the number of regional and departmental authorities across France.

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While there is consensus the current system is unwieldy, any reform cannot happen until after regional and cantonal elections set for 2015. Even then, the amount of savings it will produce is at best unclear.

"No one can predict what the savings will be for now," Minister of Reform of State Marylise Lebranchu said. "What one department is no longer doing, someone else will have to do."

What is more, if a local government shake-up entails putting public servants out of work, that will act as a further drag on the economy and push up an already bloated welfare bill, at least in the short-run.


Similar questions remain over talks with employers and unions which Hollande kicked off on Tuesday and which he hopes will trade lower and simpler corporate taxation for the rise in recruitment needed to cut 11 percent unemployment.

"We are cautious about the pace of implementation, as these reforms involve negotiations between various parties  social partners, political parties, for example," Morgan Stanley's Olivier Bizimana said.

Already, verification of how companies will deliver on expectations to increase hiring has emerged as a potential sticking point. Employers group Medef has said sector-specific targets are unworkable with Hollande insisting some measurable commitment must be agreed in forthcoming negotiations.

Hollande's so-called "responsibility pact" is drawing comparisons with the reform drive a decade ago by German Social Democrat ex-Chancellor Gerhard Schroeder that is credited with turning round the euro zone's biggest economy.

In Schroeder's case, the "alliance for jobs" of his first mandate may have achieved patchy results. But it is now seen as setting the stage for the more aggressive labor market reforms of his second mandate under the "Agenda 2010" banner.

Hollande, already battling with record low ratings for a modern-day French president, may not have the luxury of a second term. He also has to deal with French industrial relations that are historically testier than in Germany.

"I've never wanted to gloat over France," said a German official who was closely involved in Schroeder's reform drive. "We know how difficult the process is."

(Additional reporting by Emmanuel Jarry in Paris and Andreas Rinke in Berlin; editing by Mike Peacock)

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