Call Participants

ATTENDEES

Bibianna Norek

Diego Iscaro

Kristen Hallam

Presentation

Kristen Hallam

You're listening to The Decisive Podcast - insights and analysis to empower confident decision-making. Welcome to the latest episode of The Decisive Podcast. I'm your host, Kristen Hallam. Today, I have my S&P Global Market Intelligence colleagues, Bibianna Norek, and Diego Iscaro, joining me to discuss the French election and the economy. And I think we'll weave in the Olympics as well, what's happening in France at the moment. Bibianna is a senior analyst for Country Risk in Europe and CIS and is based in France. Diego is the Head of our European Macroeconomics team and is based in the U.K. Welcome, Bibianna and Diego.

Question and Answer

Kristen Hallam

Bibianna, let's start with you. Can you give us a quick recap of the election outcome in France?

Bibianna Norek

Yes. Kristen, of course, and thank you for having me today. So this election has failed to produce an absolute majority for any of the 3 main political groups. These are the left's New Popular Front, Macron's Ensemble and the far-right National Rally. And this has resulted in a hung parliament. Government formation efforts are likely to remain difficult, and we expect lengthy negotiations that are likely to continue for several weeks.

There are various scenarios that we are looking at for government information, and they include the appointment of a prime minister from the New Popular Front, which would imply a period of cohabitation for Emmanuel Macron, a broader coalition between several political groups, including centrist parties, and finally, also a technocratic government appointed by the President, who based on a letter published last week, appears to favor a broad coalition excluding both the far right and the far left.

Kristen Hallam

Right. Thank you for that recap. And Bibianna, what were the key issues driving voters in this election?

Bibianna Norek

So what we have noticed is that the turnout in this election has been very high, both in the first round with around 66% and in the second round with 67%. And this, to us, indicates great involvement by French citizens. And the significant loss in parliament receipts by Macron's Renaissance party also suggests a protest vote against the presidential camp with a sizable gain for both the left and the right. But more significantly, this high mobilization of voters, as highlighted by the results of the second round was likely driven by the aim of preventing the far-right National Rally's access to power through the so-called Republican front.

Kristen Hallam

67%, that really is a high voter turnout.

Bibianna Norek

Absolutely.

Kristen Hallam

Yes. So how will this election outcome influence policymaking, Bibianna?

Bibianna Norek

So first of all, the next government's position will likely remain fragile and any minority cabinet will be at clear risk of being toppled by a no-confidence vote if this was backed by the 2 other major political groups. We will probably see extensive negotiations to approve legislative proposals, and this slower pace of policymaking will reduce the likelihood of broader reforms being approved.

However, the new National Assembly's fragmentation will also reduce the likelihood of the most contentious policy proposals from both the New Popular Front and the National Rally being approved by Parliament, at least not without them being significantly diluted. And this would also include the proposed reversal of the pension reform.

Kristen Hallam

And how might that fragility in the government impact businesses, Bibianna?

Bibianna Norek

So we are definitely looking at a period of uncertainty ahead for France. And in the absence of lasting arrangements to create a majority, the new government will probably face more hurdles to pass major legislation. And this will also make it more difficult to pass the 2025 state budget.

And even if we were to see a technocratic government coming to power, they would also likely focus on the approval of critical legislation, such as the budget. Businesses would probably not see substantial policy changes under this scenario, while unpredictability will be greater if a New Popular Front minority government attempts to pass changes to taxation or public spending, although as mentioned, they would face significant hurdles in Parliament.

Kristen Hallam

Diego, let's bring you into the conversation. How did markets react to the election results in France?

Diego Iscaro

Thank you, Kristen, and hi, everyone. So markets reacted quite negatively when election was called in early June, but the reaction following the final results have been quite muted. So if you look at the spread between French and German 10-year government bonds, which is a measure of country risk and had peaked at more than 80 basis points in June, that spread tightened after the second round, although it remained around 10 basis points above the preelection level.

The euro, which had weakened quite significantly in June, also recovered its losses and actually strengthened quite substantially against the dollar, although this is more related to expectations about an early start of interest rate cuts in the US. And I think the reason behind this kind of muted response is that, as Bibianna explained, the election result means that some of the most fiscally costly measures proposed during the campaign are less likely to be implemented.

Now these measures include the reversal of the pension reform implemented a couple of years ago or a reduction in VAT on energy and basic goods, although I think it's fair to say that under any possible scenario, fiscal policy will still be more expensive compared to the current medium-term budgetary plan, but not significantly so. However, I think what's important to highlight is that in terms of the government's ability to implement policy and deal with the economy's challenges, France is now in a worse position than before the election, and it is likely that markets have not fully priced in this yet.

Kristen Hallam

We'll have to keep an eye on markets and see how they factor that in. Diego, how do we see the economic outlook now following the election?

Diego Iscaro

So in general, political uncertainty tends to have a negative impact on the economy. Now picture-wise, we expect any potential support from more expansive fiscal policy to be more than offset by higher bond yields and also weaker investment. Now since election has been called, there has been a significant focus on France's vehicle situation.

And if you look at France's public finances, fiscal deficit increased substantially during the pandemic as in most European countries. But physical consolidation since then has been quite disappointing. France missed its deficit target by 0.6 percentage points of GDP last year, and the monthly budget figures released so far for this year, suggests that the target for 2024 may also be missed.

If you look on the public debt side, a combination of large deficits and quite weak economic growth has led to a large increase in public debt levels. Now France's public debt to GDP ratio stands just above 100% of GDP, which is the third largest public debt ratio in the Eurozone after Greece and Italy. It is likely there will be more pressure on France to deliver on fiscal consolidation. Partly, this pressure will come from markets via an increase in borrowing costs if there's signs of significant fiscal slippages.

But also, there will be pressure from the European Union, and France is likely to enter an excess deficit procedure later this year, which, in theory, means that France will have to reduce fiscal deficit in line with EU rules over the medium term or potentially face financial penalties. And we think it's going to be quite difficult for a fragile French government to deliver on the fiscal front, and this will certainly be a test to the newly updated EU fiscal rules.

Kristen Hallam

So Diego, do you see any repercussions to the European economy?

Diego Iscaro

That's an interesting question. I think some of the most disruptive proposals made during the campaign such as reducing France's contribution to the budget or the renegotiation of the stability and growth part are unlikely to go ahead, and this is likely to provide some relief to Brussels.

But I think inevitably, the political situation in France will have an impact on EU policy. Although President Macron is still in charge of foreign affairs and defense any agreement at the EU level with budgetary implications will have to be approved by the French parliament, and this may prove to be quite difficult given how fragmented the National Assembly currently is.

There are also other channels in which the situation in France may impact the rest of Europe. One is through the exchange rate. And it is possible that a less cohesive policy and potential frictions between France under European Commission on fiscal measures, for example, maybe some downward pressure on the currency. And it's also likely that more risk of sentiment in the region, mainly to some volatility in bond spreads in other highly indebted Eurozone countries, such as Italy.

Kristen Hallam

And Diego, will the situation in France have an influence on monetary policy, do you think?

Diego Iscaro

So in principal, we don't assume you will have a major influence on interest rate's decisions. This could change if there's a significant expansionary fiscal policy in France or a large depreciation of the euro. Both events will be inflationary, would lead to fewer rate cuts than currently expected by markets.

But the ECB may choose to intervene if this is a significant worsening of market conditions. We don't think it is likely to, need to at this stage, but I think it's one of the key differences between the current situation and, let's say, the European crisis in the early 2010s, is that DCB now has the tools at its disposal to deal with financial fragmentation. First one has basically 2 tools. And the first one is the Outright Monetary Transactions program, the OMT, which was put in place in 2012, but never used so far. And also Transmission Protection Instrument or TPI, which was unveiled in 2022.

Now in practice, the limitations in terms of how any of these tools may help France, and this is because the French government would need to agree on the conditionality in the shape of a macroeconomic adjustment program to access OMT, which is likely to be politically unacceptable for any government.

And in theory at least, TPI is not available for countries under an excessive deficit procedure, which France is very likely to be later this year. But even if these tools cannot benefit France, these instruments could serve to limit contagion to other countries in the region, if there's significant worsening of market conditions.

Kristen Hallam

Right. Thank you for that. As I mentioned in the intro, we are on the eve of the Paris Olympics. Bibianna, you did an excellent report where you talked about the security considerations involved in that. And we did a blog post on your report as well. It's been one of our most popular blog posts this quarter. How has the French government been preparing for these security risks, Bibianna?

Bibianna Norek

The French Interior Ministry has been coordinating unprecedented security preparations for these Olympic Games. And just to cite a few numbers, this would include the deployment of approximately 35,000 police officers and gendarmes, 18,000 military personnel, some 2,000 foreign police officers and troops and also around 20,000 private security agents.

And security folks will face the challenge of surveilling Olympic events that will take place in 36 locations across France and not just in Paris and in the France region, but in other large cities like Marseille, Lyon, Bordeaux and L'Ile. And all of this as the risks of terrorism, sabotage, cyberattacks and protests are high in France. And security forces have already foiled a few attack plots in the past few weeks, and they will be supported by aerial surveillance and counter-UAV systems during the event.

Kristen Hallam

Wow, those are some big numbers you threw out there. Speaking of numbers, Diego, do you see any economic implications from the Olympics? Would you expect to see an economic boost, for example? Or will all the revenue go toward those security precautions that Bibianna just described?

Diego Iscaro

Yes, Kristen, the Olympic Games, the most important sporting event in the world and inevitably, they will have an effect on the economy. Now calculating the economic impact is not straightforward. There are, obviously, costs involved in financing this infrastructure and how they're spending. And there also benefits which are difficult to quantify, for example, any potential health benefits if the games are successful in promoting sports participation, for example, or any boost to long-term growth resulting from improving infrastructure.

If we focused in the short term, the most immediate and largest channel in which the games will contribute to activity is through increased tourism, although the latest anecdotal evidence, just that the number of tourists arriving in Paris for the games may be below expectations, but we still expect some positive contribution from tourism during the duration of the games.

Now spending on security as well as the organization of the games will also contribute to activity. And it's also the spending on infrastructure, which most of it has been already materialized. So all in all, we expect modest boost growth in the third quarter of the year, but some of this growth is likely to actually be offset by weaker activity during the fourth quarter of 2024 as some of these extra spending is likely to be a correction after the games are finished.

Kristen Hallam

Thanks. There's some interesting, long-term things that you mentioned there that I hadn't thought about before, like health impacts and things like this. And I was speaking earlier with some of the economists on our Purchasing Managers Index Team, and they were talking about the 2012 Olympics in London and tracking some data on spending on sports equipment and things like that in the wake of the Olympics. So it'll be interesting to see if some of those effects materialize. Will either of you be attending any Olympic events?

Diego Iscaro

Unfortunately, not me, although I'll be following very closely, that, yes, but particularly, the Rugby Sevens, which is my favorite event.

Kristen Hallam

I'm a rugby fan as well. Excellent. How about you, Bibianna?

Bibianna Norek

I'm hoping to attend some of the events planned for Lyon, which is where I'm based.

Kristen Hallam

Nice. All right. So what indicators will you be watching in the near term? Bibianna, let's maybe start with you. And then, Diego, we can talk about economic indicators.

Bibianna Norek

Sure. Thank you, Kristen. I actually really like this question because we always build our analysis around indicators in order to make it more actionable for our clients. So things that we would be looking at for France would be developments in coalition and government formation negotiations.

And something to keep an eye on, in particular, would be disagreements within the New Popular Front coalition as there is a marked policy differentiation between the parties and the coalition, particularly when it comes to social and economic policies. And so far, they have failed to agree on a common candidate for Prime Minister.

We will also be monitoring cause for protest by trade unions, student unions, party supporters and protest groups. And protests will be particularly likely, according to us, if La France Insoumise, which is the largest party within the New Popular Front was sidelined from government formation.

Kristen Hallam

Right. And Diego, any indicators that you'll be watching in the near term?

Diego Iscaro

Sure. So on top of indications of which measures will be included on next year's budget, which will be the first challenge on the economic front for the new government, and we have to present it to parliament in October, I'll be keeping a close eye on the monthly fiscal figures, and they would give us an indication if France is likely to meet its fiscal targets for the year. We currently think it is unlikely this will happen, but obviously, we'll follow the data. And I'll also be following developments in bull markets, particularly spreads between French and German bonds.

I also think it's important to keep an eye on data on the activity side, particularly on PMIs, to assess if there's any suggestion that political uncertainty may be having a negative impact on the -- on activity. Certainly, before the election, we were expecting a gradual, cyclical upturn in France alongside other Eurozone economies, and we need to keep a close eye on the data to see if uncertainties stemming from the political situation is having a greater-than-expected impact on economic activity.

Kristen Hallam

Right. Lots to watch there. Any final thoughts for our listeners. Maybe, Diego, we'll start with you as you already have the floor.

Diego Iscaro

Thank you. Yes, I mean, from my side, I wanted to highlight that when we run our forecast this month, higher political uncertainty has led to a minor downgrade of our latest growth projection. At this stage, we do not expect a large impact on growth, but it certainly raises the downward risk around the baseline forecast, not only when looking at the very short term to the next year or so, but also when assessing the French government's ability to pass legislation to deal with the country's structural challenges and eventually boost potential growth.

Kristen Hallam

All right. And how about you, Bibianna, any final thoughts?

Bibianna Norek

Thanks, Kristen. I think on my side, I would flag that over the past couple of months, we have seen civil unrest in New Caledonia over the French government's decision to pass a new electoral law. And this unrest has led to the death of 10 people and over EUR 1 billion in damages. And so the formation of a new government will be a very important indicator of the trajectory of dialogue between New Caledonia and Mainland France and also of its social stability.

Kristen Hallam

Right. Well, thank you so much, Bibianna and Diego, for taking the time to share your insights with us. That wraps up this episode of The Decisive Podcast. Thank you for listening to the decisive podcast from S&P Global. Please subscribe and join us for next week's episode. Until then, stay curious and stay informed.