Analysis and consequences of Finance Bill 2014.

France’s 2014 provisional budget, which is due to be examined by the country’s Parliament through the month of December, predicts a total public deficit of 3.6% GDP in 2014. This follows a sharp increase in the 2013 deficit, initially expected to come in at 3% but now estimated at 4.1%. Whereas the Government’s 2014 GDP growth forecasts are more or less in line with economists’ consensus of plus 0.9% - and have therefore been called “plausible” by the brand new Haut conseil des finances publiques (an independent body chaired by the President of France’s Cour des comptes and tasked with validating gouvernment estimates) - as was the case in 2013 there is a good chance that tax receipts will be lower than expected, confirming our hypothesis that the optimal tax threshold has been exceeded and strengthening in turn the hoary old expression that “too much tax kills tax”. On the other side of the ledger, the government has promised a historic €15 billion cut in spending in 2014. In reality, however, this “reduction” means that spending will “only” increase by €3 billion (vs. plus €30 billion in 2013), to be compared with the €18 billion rise that would have been its spontaneous trend. Otherwise, the provisional budget also expects, for the first time ever, that the French state in the narrow sense of this term will cut total spending (by €1.5 billion, excluding service of the debt and old age pensions). Of course, this is the same amount as local authorities are being asked to cut, following the reduction in the central grants they receive every year. Lastly, the nation’s various entitlement programmes are being asked to make savings of €6 billion (still in comparison to their “natural” trend). On the face of it, these estimates are all very unrealistic. Indeed, the most likely scenario is that the 2014 public deficit will again exceed 4% of GDP.

This outlook has two major implications for investors. Regarding fixed income instruments, the rise in long-term interest rates since the nadir was reached last May (when 10-year OAT French Treasury bond rates hit a historic low of 1.67%) should continue (the current rate in October is 2.40%) This is due to a generalised rise in interest rates worldwide, notably in Germany (important because the Bund is the Eurozone’s benchmark treasury bond). It will undoubtedly be accentuated by an increased risk premium (currently about 50 basis points) on French bonds vs. their German counterparts. Most people therefore feel that it does not make any sense to invest in French Treasuries today, since any rises in interest rates will automatically translate into lower bond prices. As for equities, in a context where global recovery is being driven by the emerging economies (the IMF has just announced that three-quarters of the 3.6% rise in 2014 global GDP should come from the emerging countries, with China alone accounting for 40%), large caps listed in Paris who have been able to reduce their cost base and adapt to the new economic environment should continue to benefit from the global upswing. Average equity yields are high (3% for the CAC-40) and price-earning ratios look reasonable (around 12). With good prospects for earnings growth, shares look a good bet over the next three to seven years.

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