Balladur bond opens up a new front for France: Peter Torday examines the French way of fighting recession

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The Independent Online
TOMORROW, the French government floats an innovative bond on France's financial markets designed to finance the fight against unemployment without busting the budget.

While the European Community wrangles with how best to bring down unemployment and regenerate growth, France is tackling the problem on a wide front. The Balladur Bond, named after Edouard Balladur, the shrewd technocrat who was appointed Prime Minister of the new centre-right government in April, could raise more than Fr40bn ( pounds 4.7bn) and will ultimately be redeemed through conversion into forthcoming privatisation stocks. The government yesterday set a coupon rate of 6 per cent for the new issue.

The bond will undoubtedly help, but France is doing at least as much on the monetary policy front. Earlier this week, the Banque de France pushed official rates below their German equivalents for the first time in 26 years, save for a brief but unhappy attempt in 1991 that had to be reversed.

It was the ninth reduction since the centre-right election victory in April and the fall below German rates is expected to hold this time.

So far the signs have been good. The cut has not undermined the franc's strength against the mark inside the European exchange rate mechanism (as was the case in 1991) for the simple reason that French economic fundamentals look significantly rosier than those of Germany on a number of aspects.

Growth: Although France is decisively in recession, the downturn is a good deal less worrying than in Germany. The government expects the economy to contract by 0.8 per cent in 1993, perhaps the worst decline since the Second World War. The latest survey by Insee, the French statistics agency, suggests that gross domestic product could shrink by 1 per cent this year. A 2 per cent decline - or worse - is foreseen for Germany.

Budget deficit: As in Britain, the French fiscal shortfall has been swollen by the recession, but Mr Balladur has already taken measures to control it. In contrast, the German deficit is threatening to spiral out of control. In strict statistical terms, at 5.3 per cent of GDP, the French deficit is a little higher than the estimate for the Federal German shortfall. But much of the German fiscal crisis is due to off-budget spending and the overall fiscal deficit is thought to be much deeper.

Inflation: At an annual 2 per cent in May, French inflation is less than half Germany's rate.

The result is that the financial markets have shone a favourable light on France. The central bank is exploiting this to the hilt, urged on by a government deeply worried about France's 3.1 million unemployed.

The Banque de France has cut its key intervention rate to 7 per cent and is using the level of Dutch rates as its goalposts. Trading on a long history of current account surpluses and monetary rectitude, the Netherlands has pared three-month money rates to about 6.5 per cent - in theory, giving France another chance to cut rates soon.

The Banque has been careful to let the market lead the process. For most of this month, French short-term rates have traded below German rates and French long rates - a barometer of market expectations over inflation trends - are about to sink below those of Germany.

'The whole French yield curve out to seven years is now below German yields. Rates for 10-year bonds should fall below German levels within a month,' said Marie Owens Thomsen, French economist at Midland Global Markets.

The process of cutting French rates will be vigorously pursued whether the Bundesbank lowers its rates or not. But, as Jane Edwards of Lehman Brothers points out, there are limits.

'France and other countries are taking advantage of appreciating currencies in the ERM to cut their rates,' she says. 'But there are limits on how far rates can be cut within a fixed exchange rate system before a devaluation of the mark is priced in.' Eventually, the Bundesbank will have to cut its rates as well, to keep others heading downwards.

Tomorrow's bond issue represents the fiscal side of the equation, although it has worried the markets, which detect a whiff of economic U-turn. Before the bond's announcement, Mr Balladur won plaudits for an austerity-laced budget package aimed at reining in the fiscal deficit. The franc strengthened inside the ERM and allowed the central bank to redouble its efforts to cut rates.

The bond took shape after Mr Balladur realised that the need to fight unemployment was even greater than he had thought. The government now predicts that the figure will rise by a further 350,000 this year.

With at least Fr10bn from the issue to be spent on maintaining jobs, largely in the public sector, the bond initially smacked of a shift in government priorities from protecting the franc fort to a US-style 'go for growth' policy.

That interpretation is probably far from the truth. Like almost every decision made by Mr Balladur since moving into the Hotel Matignon, this one is clever and well thought out. Not only is the bond issue technically ingenious, but it also pays attention to the recession, though modestly enough not to damage the government's hard- won credibility on the markets.

Importantly, there are funds waiting to be tapped. A prolonged period of high interest rates in France lured huge sums from individual savers into the French money markets.

But with the slide in rates accelerating, these money-market accounts are increasingly unstable. 'A flood of money is about to pour out, ' Ms Owens Thomsen says. 'France is starved of investment opportunities compared to Britain. Any opportunity like the Balladur bond looks good.'

The new bond is intended to appeal to investors as an attractive alternative home to the money funds. French bond prices have risen as interest rates have fallen, and the prospect of further cuts - some analysts see 4 per cent on next year's horizon - makes the Balladur bond more attractive.

The bonds also have bells and whistles in numbers. Convertibility into future privatisation issues - 21 prospective candidates for sell-off have already been annnounced - may prove a good vehicle for attracting French savers into the equity market.

There is also a tax incentive. Bonds placed in individual equity plans will qualify for a holiday from capital gains. If converted into privatisation shares, this paper will also be free of capital gains if held in these plans, but only after an eight-year period.

Despite the complexity of the conditions attached to the issue, Paris analysts agree that Mr Balladur may have helped to create a market for the new shares.

Not all worries have been banished. Some analysts worry about the consequences of the privatisation legislation running into trouble or the shares proving unattractive. Although the government has a majority in the national assembly, borrowing from future potential receipts appears less acceptable to the investment community than a conservative policy of waiting until the privatisation proceeds come in.

Yet the immediate economic problems mean the government has little alternative. Lower rates have also helped to push aside concerns, and the lure of a positive market reception tomorrow is all that matters.

(Photograph omitted)

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