Analysis: Hollande's growth drive dogged by reality of austerity

PARIS Wed Jul 25, 2012 5:01am EDT

France's President Francois Hollande is presented a chef's jacket with his name during a reception of the ''Club des Chefs des Chefs'' (Club of Leaders' Chefs) at the Elysee Palace in Paris, July 24, 2012, following the International meeting in France. REUTERS/Jacques Demarthon/Pool

France's President Francois Hollande is presented a chef's jacket with his name during a reception of the ''Club des Chefs des Chefs'' (Club of Leaders' Chefs) at the Elysee Palace in Paris, July 24, 2012, following the International meeting in France.

Credit: Reuters/Jacques Demarthon/Pool

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PARIS (Reuters) - The champion of a moderate stimulus plan for Europe, at home French President Francois Hollande is turning his back on the sort of infrastructure investment he hopes will revive European growth.

His cash-strapped Socialist government is considering scrapping all but the most needed projects as it is forced to weigh questionable economic benefits in an era of belt-tightening.

Yet, more investment in infrastructure lies at the centre of the 120 billion ($145 billion) European financing package that the French leader spearheaded in his first months in office.

In a country already crisscrossed with high-speed trains and world-class motorways, the national audit office said many of France's highest-profile projects in the pipeline were incompatible with a push to rein in the deficit.

Its call has not fallen on deaf ears in the government, which has pledged to be pickier about projects and is even considering ditching some planned high-speed rail lines.

Not only is the utility of more infrastructure an open question, but some economists say the knock-on boost to jobs and consumer spending hoped for may well not materialize.

"A stimulus plan focused on infrastructure projects that only makes the deficit worse bears medium-term risks that outweigh the weak boost to growth in the short-term," said economist Denis Ferrand at think-tank Coe-Rexecode.

BELT-TIGHTENING

Hollande rode to power in May, pledging to shift Europe's focus away from austerity towards boosting growth with a strategy for firing up investment mainly in infrastructure and increasing lending to smaller companies.

Having pledged during the campaign to decimate France's public deficit and debt, Hollande counted on pro-growth rhetoric to make his belt-tightening plans more palatable to voters.

At a June summit, European leaders signed up to jointly-underwritten project bonds aimed at financing transport, energy and broadband and for mobilizing billions of unused EU funds earmarked for developing poor regions.

In addition, there are plans to ramp up the European Investment Bank's capital by 10 billion euros so that it could increase its lending capacity by 60 billion euros.

Prime Minister Jean-Marc Ayrault has urged ministries to come forward with project proposals so that France gets a share of the cash. But while the government has its eye on the new money, it is also planning stiffer controls on its own public investment and is charging former EADS CEO Louis Gallois to vet projects in the works.

"Only the most pertinent projects will be retained," said a finance ministry document drafted to prepare debate in parliament on the 2012 budget.

Hollande's government has embarked on one of the biggest reductions in the deficit that modern France has ever seen as the government struggles to cut the budget gap to 3 percent of GDP next year from 4.5 percent this year despite a deteriorating growth outlook.

In a sign of greater caution towards spending, Budget Minister Jerome Cahuzac said last week that the government may axe plans for a major, but costly extension of the high-speed train network.

"It's fair to ask whether we should extend this or that TGV line for marginal time gains," Cahuzac said.

The state auditor estimates public investment in transport, including 14 TGV lines due to be built by 2020, would top 150 billion euros for the central government and local authorities.

The minister in charge of urban planning, Cecile Duflot, said last month that plans should be reconsidered for a major overhaul of infrastructure around Paris that Hollande's conservative predecessor Nicolas Sarkozy had championed.

Also, at a European level, Hollande advisor Philippe Aghion said there should be less focus on grand infrastructure projects.

"The EIB invests too much in infrastructure and transport and not enough in energy and growth enhancing sectors," said Aghion, who is a teacher at Harvard.

FLAWED ECONOMIC LOGIC?

France already ploughs more money into investment than most other EU countries with gross capital formation in the public sector standing at 3.1 percent of GDP last year, a level that has varied little over the past 30 years.

One of the main arguments in favor is that it generates further spending and activity, boosting growth as the injection of public funds filters through the economy.

However, economists warn that such a boost may prove more muted than in the past because over-stretched consumers and companies not only in France but across southern Europe are more likely to be frugal with any spare cash that comes their way.

"If you're a borrower and you have taken on too much debt and you get additional income, what do you do? You try to repay your debt, you're not going to spend it," said economist Claudio Borio.

"The multiplier effect is very low," said Borio, who is deputy head of the monetary and economic department at the Bank for International Settlements.

In France, strained corporate balance sheets make it more likely that companies benefiting from an increase in public investment will reduce debt rather than take on staff and make investments. Corporate debt is running at a record 66 percent of GDP while profits are at their lowest level since 1985, which is weighing on investment.

Households' balance sheets are faring little better, which means extra cash that trickles down to them risks being saved rather than spent. Household debt is also running at a record 55 percent of GDP and they are already saving record amounts.

With little scope for more public investment, the government is counting on the private sector to spend more with financing from a new public investment bank, which is supposed to consolidate various existing state-backed financing bodies.

It would focus in particular on small and mid-sized companies, which are having the most trouble raising funds.

However, Ferrand at Coe-Rexecode said the best way to fix the growth outlook was to stick to the government's deficit targets and carry out reforms to make companies more competitive internationally.

"A real, economically pertinent stimulus plan is one that allows us to get back on track and restore our competitiveness, which has been the French economy's weak spot," Ferrand said.

"A classic Keynesian stimulus plan does not seem to us to be the best way forward," he said. ($1 = 0.8253 euros)

(Addition reporting by Daniel Flynn, editing by Mike peacock)

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