France eyes more deficit cuts as ratings eyed

France's Finance and Economy Minister Francois Baroin (R) and Budget Minister and government spokesperson Valerie Pecresse speak to the media in the courtyard of the Elysee Palace after emergency talks on the economy in Paris, August 10, 2011.

PARIS (Reuters) - French President Nicolas Sarkozy on Wednesday ordered his finance and budget ministers to find new ways to prune the public deficit as markets fretted over the country's strained finances and banks in the wake of a U.S. debt downgrade.

Shares in French banks -- among the most exposed to Italian and other peripheral euro zone government debt -- tumbled in afternoon trade as fears about the currency bloc's debt crisis moved back to the forefront of investor concerns.

Sarkozy, who played a leading role in frantic diplomacy over the weekend aimed at halting two weeks of market turmoil, had earlier summoned his top ministers and central bank chief to emergency talks, interrupting the summer recess.

He urged French political parties to support his proposal for a constitutional rule to limit future deficits which is set to be defeated if put to a special two-chamber parliamentary vote.

Budget Minister Valerie Pecresse said after the talks she would target tax loopholes in the 2012 budget.

"We will not deviate one inch from our deficit-cutting targets," she told BFM television.

France -- the most indebted of the euro zone's six AAA-rated states -- has vowed to cut its deficit to 4.6 percent of GDP next year and 3 percent in 2013, down from 7.1 percent in 2010 and an expected 5.7 percent this year.

Yet its public debt, at around 85 percent this year, is well above the euro zone's recommended 60 percent of GDP ceiling and the market turmoil deals a blow to hopes investment will pick up after a bleak second quarter.

Sarkozy asked Pecresse and Finance Minister Francois Baroin to outline suggestions to speed up deficit cuts at an upcoming August 17 meeting with Prime Minister Francois Fillon. A further meeting on August 24 will formally agree on the steps.

"Whatever the impact of global uncertainty, of the announcement of the U.S. downgrade by S&P, the nervousness of markets -- regardless of any of these external parameters, we will take the necessary measures to reach our targets," Baroin told reporters after the meeting.

DIVE

The three major rating agencies reaffirmed France's AAA rating on Wednesday, and said its outlook was stable, but markets remain concerned that French banks are among the most exposed to a worsening of Europe's government debt crisis.

"The pressure was there before the U.S. downgrade. France is the euro zone's second leg. if it stumbles the bloc will really start to limp," said Jean-Christophe Caffet, an economist at Natixis.

Volatile trading in shares of Societe Generale and other French banks on Wednesday appeared to be inflamed by a perfect storm of rumors fueled by Twitter postings, market blogs and a now debunked newspaper report.

Shares of Societe Generale plummeted as much as 23 percent before trimming some losses to end 14.7 percent lower on the day. BNP Paribas dove 9.5 percent.

Sarkozy was at the center of a July 21 agreement among euro zone leaders to give the EFSF rescue fund the power to buy sovereign bonds on the secondary market and aid Greece with a new multibillion-euro bailout.

With the opposition Socialist Party on board, parliament should pass the resulting adjustments to the 2011 budget at special sessions on September 6-7 -- tacking an extra 15 billion euros onto France's public debt by 2014, equivalent to adding 0.75 percentage point to the debt-to-GDP ratio.

Lawmakers on the left, however, have vowed to block Sarkozy's proposal for a constitutional "debt brake" if it goes to a two-chamber vote in coming weeks, part of the jockeying for political position ahead of a 2012 presidential election.

The Socialists oppose tampering with the Constitution, noting the reform would have limited impact as numerical deficit ceilings would be set by particular governments anyway.

Markets, however, see the constitutional move as symbolic of France's commitment to fiscal prudence and some analysts fear that rating agencies could use a failure of the initiative to put France on negative outlook, or on review for a possible downgrade.

The strident head of Sarkozy's conservative UMP party, Jean-Francois Cope, told Le Figaro in an interview to be published on Thursday that 90 countries already had such a debt control rule. He challenged the left to sign up or stand accused of sacrificing France's interests for the sake of party politics.

France has not produced a balanced budget since 1974, but like others in the euro zone, is struggling with low growth. Data on Friday is expected to show the economy expanded just 0.2 percent in the second quarter.

Government officials have already said they will try to squeeze at least 3 billion euros in extra revenues from the 2012 budget, to be debated from September. The Senate finance committee is eyeing between 5 and 10 billion.

With an election just eight months away, Sarkozy will steer clear of broad tax hikes, but a group of advisors have suggested slapping new taxes on the super-rich or nudging up value-added taxes from the current rate of 19.6 percent.

To avoid touching the overall rate, the group suggests raising the reduced VAT rate of 5.5 percent, applied to restaurants and labor-intensive services like home repairs, to 8 percent and also setting higher rates for some luxury goods.