RPT-Patience wearing thin with French reform results

Fri Mar 7, 2014 2:30am EST

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* EU Commission subjecting France to enhanced monitoring

* Markets so far indulgent though fiscal targets seen at risk

By Leigh Thomas

PARIS, March 6 (Reuters) - France is facing pressure to deliver on long-promised, deep budget savings in the next couple of weeks to keep the increasingly strained faith of its EU partners, bond markets and ratings agencies.

Unimpressed with French efforts so far, the European Commission warned on Wednesday that Paris would miss its deficit-reduction targets in the absence of further action.

The European Union's executive arm singled out France (and Slovenia) for stepped-up monitoring to check that President Francois Hollande's government finally makes promised reforms and budget savings.

Crucially, some investors who until now have given France the benefit of the doubt are saying its status as a top issuer at the core of the Europe's bond market is not guaranteed.

"The margins for manoeuvre are non-existent for potential disappointments," Franck Dixmier, head of fixed income in Europe for Allianz Global Investors, which is the 30th biggest private holder of French debt according to Thomson Reuters data.

"If France disappoints ... its status in the markets will deteriorate," he told Reuters.

The Commission has already given France two extra years - until 2015 - to bring its deficit in line with an EU-limit of 3 percent of gross domestic product on condition the euro zone's second-biggest economy is reformed in depth.

The government currently aims to reduce the public deficit to 2.8 percent of GDP next year from what it estimates will be 3.6 percent this year. The Commission however sees the deficit falling to only 3.9 percent next year from 4.0 percent this year.

With that target at risk after tax revenues fell short of estimates last year, the government increasingly says what is important is simply that the deficit is falling, budget savings are made and big reforms are carried out.

Despite record low popularity ratings, Hollande's government will have to detail in the coming weeks exactly how it plans to wring just over 50 billion euros ($68.7 billion) savings from the budget in 2015-2017.

Further savings are also needed to finance Hollande's plans for a cut in payroll tax on companies as part of what he has dubbed a "responsibility pact" aimed at recovering lost competitiveness.

FINANCES UNDER STRAIN

Though officially the government considers its target for a deficit of 3 percent of GDP next year is not a lost cause, both the Commission and the national audit office have voiced strong doubts it will be met.

The Cour des Comptes audit office said last month that the Finance Ministry tends to overestimate tax revenues, which frequently leaves a hole in the budget. It could be as big as 4 billion euros this year.

Already last year the central state's budget deficit was 2.7 billion euros bigger than expected because tax revenues fell short of hopes.

With final figures not due until late March, that shortfall raises the risk that the overall deficit for 2013 was worse than the 4.1 percent of GDP that the government had targeted.

Any overshoot this year would have to be absorbed by 7 billion euros in rainy-day reserves built into the budget, leaving no room for unbudgeted spending in case of emergencies.

"The fiscal policy flexibility in France is limited which together with the policy challenges imply a continued risk of missing fiscal targets," Moody's France analyst Dietmar Hornung said on a conference call.

PATIENCE WEARING THIN

Though France has already been stripped of its AAA credit rating, bond investors continue to indulge France, attracted to the liquidity offered by its bonds and richer yields than those on low-risk German alternatives.

Investors have over the last year demanded only about half a percentage point extra yield to hold French bonds instead German bonds, down from nearly a point and a half during the darkest days of the euro zone crisis in 2011 and 2012.

Strong appetite for French debt was evident in a long-term bond auction on Thursday which saw investors put in bids worth more than twice the 8 billion euros sold.

France can count on a solid investor base with a large chunk of the 65 percent of French debt in foreign hands owned by other countries' central banks, looking for liquid assets where they can park foreign reserves.

Nonetheless, the French central bank and the audit office have voiced concerns that investors' patience may ultimately run out if France puts off reining in its deficit yet again.

"If it gives the impression that it never meets its targets, that it puts them off indefinitely, its creditworthiness with markets and general credibility could be put into question," Bank of France Governor Christian Noyer said last month.

The national audit office estimates a one-percent increase in France's borrowing costs would add 2 billion euros in debt servicing costs annually in the first year and 15 billion euros after 10 years.

That would come on top of the 52 billion euros in debt servicing costs France already forks over to its creditors each year, which the audit office points out is more than annual budget for the justice, foreign and culture ministries combined.

"Winning investors confidence is a long process that takes time, but there's nothing faster than losing market," Allianz's Dixmier said.

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