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Analysis: Sarkozy in fight for French AAA, political future
October 24, 2011 / 5:21 PM / in 6 years

Analysis: Sarkozy in fight for French AAA, political future

PARIS (Reuters) - Nicolas Sarkozy is in one of the most critical weeks of his presidency as he battles to mend his differences with Germany over a euro zone crisis that threatens both France’s economic wellbeing and his own political future.

France's President Nicolas Sarkozy arrives for an afternoon visit at the Clinique de la Muette maternity clinic in Paris October 22, 2011. REUTERS/Gonzalo Fuentes

A spike in French bond spreads over German Bunds mirrors the rising pressure Sarkozy is under as the relentless advance of the euro area’s debt crisis throws France’s top-tier position in the bloc alongside Germany into question.

The premium investors demand to hold French 10-year bonds soared to 120 basis points over Bunds, three times the normal level, since Moody’s said last Monday it was scrutinizing the outlook on France’s triple-A rating in light of slowing growth and costly euro zone bailout commitments.

Penned in between hawk-eyed rating analysts and a disgruntled electorate, Sarkozy is grappling with one hand to ensure a euro zone plan promised for Wednesday does not place the burden of propping up banks on the state, and must use the other to find fresh deficit-cutting measures without burying his chances of winning a second term in a 2012 election.

France pays very low interest on its debt and last week’s jump in yields is mainly psychological -- but a prolonged rise could still add to fears that France’s AAA-rating is in peril.

“The jump in the spread over Bunds embodies everything. This is a dramatic time for France,” said French economist and past government advisor Jacques Delpla.

“Since last Tuesday, France suddenly looks like it’s in the second division in Europe. If France does not put its house in order, it runs the risk of being put on a negative outlook.”

France has been under strain since early summer, as concern grew about the level of its banks’ lending to Greece and other peripheral euro zone countries. Market jitters wiped billions of euros off French banking stocks in just days.

More recently, two fresh issues have rattled markets: the steady rise in Socialist Francois Hollande’s lead over Sarkozy in opinion polls, and the government’s admission that it will further revise down growth targets in the weeks ahead.

The surge in French bond spreads to their highest since the euro’s launch may not be backed by fundamentals, but pessimism is rife in France.

Marc Touati, chief economist at Assya Compagnie Financiere, believes 2012 will be France’s grimmest year in a long time.

“France will certainly lose its AAA debt rating, and we have to prepare for a very strong social crisis. Good luck everyone,” he said, echoing panicky talk among bankers who are now openly asking whether the euro could collapse.

CUDDLY TOY

Outsiders are more sanguine, but agree much is at stake this week, not least France’s standing in Europe after Sarkozy caved in to Merkel and dropped his push for the EFSF bailout fund to become a bank that could tap ECB funding.

EU leaders are near agreement on bank recapitalizations and how to leverage the EFSF, but differences remain on other issues and final decisions have been deferred to Wednesday evening.

A photograph printed in French daily Le Monde of Merkel handing Sarkozy a cuddly toy for his newborn daughter during weekend talks in Brussels almost seemed to poke fun at the upper hand Berlin has over an enfeebled Paris.

“Nobody benefits from a weakened France. It certainly doesn’t help the Germans (and) having Berlin as the new Brussels would be dangerous,” said Nicholas Dungan, a senior fellow at the Atlantic Council in Washington.

“I can understand the apprehension (among French analysts) because if France starts looking like a second-division player then its leverage over Germany diminishes,” he said.

“That apprehension will disappear if the circumstances that caused it disappear, which means they must come up with a solution that solves the immediate problem and puts a mechanism in place so it doesn’t happen again. They don’t need to come to long-term institutional arrangements this week but they need to get rid of the Greek debt problem once and for all.”

A solemn Sarkozy told ruling party officials last week that Europe’s fate would be determined in the next few days.

Providing Europe’s leaders can come up with their promised euro crisis plan on Wednesday evening, Sarkozy must immediately turn his attention to his fiscal targets, now that France’s 2012 growth risks falling well short of a target 1.75 percent.

Whether or not the euro rescue plan leads to France having to help banks boost their capital, Sarkozy has warned his cabinet he may have to take new deficit-cutting steps on top of the 11 billion euros in savings targeting in the 2012 budget.

“If we find a global solution to the euro zone’s problems we will have better economic visibility on Europe and France,” said government spokeswoman and Budget Minister Valerie Pecresse, as a contraction in private sector activity pointed to gloom lasting through to the end of 2012.

“If we need to make more effort we will,” she said.

Sarkozy would be most likely to axe more tax loopholes than seek politically dangerous spending cuts, but he risks alienating the business elite he has been at pains to keep friendly to him during his four years in office.

Despite foreign policy successes, like his leadership on the war in Libya, Sarkozy’s popularity ratings are still mired at near 30 percent. Many French, fed up with high unemployment and low purchasing power, say they would have more faith in the left to run the economy.

Sarkozy normally flourishes in times of crisis, yet he bickered at the weekend with the leaders of Britain and Italy, hinting at the strain he is under and at Paris’s isolation.

He is widely expected to address the nation after Wednesday, but his office would not confirm a TV appearance.

While the euro zone crisis and France’s AAA-rating matter less to voters than their own spending power, some French media are already sounding the death knell for Sarkozy. Two news magazine covers recently pronounced “the end of a reign.”

“Sarkozy has never lacked a survival instinct, but he will need a lot more than that to face the six months ahead and keep a hope of reelection,” read an editorial in the daily Le Monde.

Additional reporting by Jean-Baptiste Vey and Vicky Buffery; editing by Anna Willard

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