Aligning France's economy with the three “stars”
All three "stars", the oil price, the euro exchange rate and interest rates, are currently aligned: since summer 2014, the crude price has halved and the euro/dollar exchange rate has shed nearly 20%; nominal interest rates are at an all-time low and the French state is even borrowing at negative rates on maturities up to five years. To what extent can the French economy fully benefit from this favourable astral configuration?
The fall in oil prices is the factor that will most underpin the growth of advanced economies in 2015. It has mainly resulted from a positive shock on energy supply rather than a negative shock on demand. We can nevertheless draw a few lessons from the 1986 oil price collapse. The Brent price at that time fell by the same percentage as recently but it did not have a significant positive impact on growth in France, even though the country was a much bigger consumer of oil then than it is today. It was only from 1988, two years later, that growth in France started to really accelerate and the unemployment rate to decline. Why? Because, like today, French companies were suffering from deteriorated profit margins. The lower oil cost was then used by companies firstly to restore their profitability and competitiveness, and only at a later stage, once this adjustment over, to increase investment spending and employment. We can probably expect a similar chain of events in the current environment.
Will the euro's depreciation facilitate and speed up this necessary adjustment in companies' competitiveness? The short answer is yes, but we should not overestimate its positive impact. Firstly, since several other currencies such as the yen and certain emerging market currencies have also depreciated against the US dollar, the fall in the euro's effective exchange rate against all other currencies has been smaller than that against the green back alone. Secondly and even more importantly, around half of France's foreign trade remains within the eurozone, where France has lost competitiveness in terms of unit labour costs. As a result, France's cost competitiveness in relation to all of its trade partners (inside and outside the eurozone) has barely improved over the past year: the positive effect of the euro exchange rate depreciation was largely offset by a further rise in relative unit labour costs. Moreover, even if the euro has probably not yet bottomed out against the dollar, it would be dangerous to put all our hopes on a continuous depreciation of the exchange rate. Here also, the mid-1980s example holds lessons for us: at the start of 1986, the exchange rate of the French franc against the US dollar was even lower than today, at less than 0.90 expressed in euros; two years later, it had risen to the equivalent of around 1.20.
As regards the European Central Bank's (ECB) policy and the fall in interest rates, their effects are the least powerful compared to those of the other stars in the specific case of the French economy. Unlike the situation prevailing in other eurozone countries, credit conditions in France were already extremely accommodative, even before quantitative easing was initiated. First, according to ECB data, interest rates on new loans to SMEs are the lowest in France, where they fell even further in early 2015. Second, France is the only eurozone country where bank loans to the business sector have risen significantly over the last year. This is all the more notable since it is also in France that corporate bond market net issuance has been the largest. As a result, France is the only country where the debt ratio of the nonfinancial corporate sector (in relation to GDP) continues to increase. All of this shows that obstacles to investment in France are not to be found on credit markets but rather in the deterioration of the profitability and thus of the self-financing capacity of the business sector, a symptom of which is higher debt.
In summary, it is not enough for the three stars to be aligned: France's economy must also be aligned with them. And there is no time to lose because this positive astrological configuration will not last indefinitely…
Olivier Garnier, Group Chief Economist