Franc will test French commitment to union

COMMENT

The battering the franc took on the foreign exchanges will test afresh the French government's commitment to monetary union. If the pressure continues next week, official interest rates will be forced to rise - something the economy needs like a hole in the head. The virtuous cycle of interest rate cuts against the background of a strengthening franc that the Banque de France was able to achieve over the summer is now a distant memory.

The problem is that the French government has incompatible objectives at the very heart of economic policy. During his election campaign, Jacques Chirac pledged to make unemployment the "priority of priorities". With unemployment figures being much worse than expected in August, a cut in interest rates is called for to stimulate an economy that is flagging fast.

However, with his appointment of Alain Juppe as prime minister, President Chirac also signed up for the austere economic policies needed to conform with the Maastricht criteria for monetary union. The budget deficit of 5 per cent this year is to be cut - mainly through tax increases. The government has shown no sign of wanting to use the leeway provided by the 15 per cent bands within the ERM.

The 64,000-franc question is whether the Chirac government has the will to persist with these painful economic policies. Many have lost by speculating against the willingness of the French authorities to defend the franc, but that was under a previous administration and at a time when the unemployment problem seemed less entrenched.

What is clear is that the very tests inflicted by the market on that commitment make it all the more difficult for the French government to achieve its twin goals. By keeping interest rates above the level warranted by the state of the real economy, growth is constrained, so worsening the outlook for the deficit and making it more difficult to bring down unemployment.

The French will no doubt blame the nasty Anglo-Saxon speculators once more. At the Halifax summit in June, President Chirac likened currency speculation to Aids. The markets' riposte is to point to the genuine quandary the authorities find themselves in. There is an uneery echo of the events that unfolded before Britain's ejection from the ERM. But given the French elite's commitment to monetary union, it could take social unrest to force the issue.

Things could hardly be worse at Eurotunnel

In the old days, the First National City Bank of Moose Jaw, tiny though it might have been, was perfectly capable of sinking an entire corporate rescue negotiation by withholding approval at the last moment. When unanimity among bankers was the normal requirement, a handful of lenders could blackmail the rest with demands for special concessions, and refinancings often ended up in a long and unseemly squabbles between bankers. History is about to repeat itself with Eurotunnel. The company's bankers must produce a unanimous agreement before a refinancing can go ahead.

After the early Nineties' corporate rescues, the Bank of England lobbied long and hard to persuade bankers to include majority voting in loan agreements so as to escape these problems of delay and dissension. Eurotunnel, where an 85 per cent majority vote has been needed to change the terms of the loans, was often held up as an example of how to get round the corrosive arguments brought by the need for unanimity.

Unfortunately, as Eurotunnel revealed yesterday, that does not apply where new money from the junior lenders is concerned - and the suspension of pounds 700m a year of interest payments amounts to lending the company more, as the interest rolls up.

This may not be entirely bad news for shareholders, provided they keep their nerves. This is a big proviso since the shares have already fallen pounds 2.32 this year. Today they change hands at less than pounds 1 each. Pity those who bought at pounds 13. Eurotunnel hopes to have an agreement with its principal banks by January. The longer the subsequent rows over getting the rest of the 225-strong syndicate into line, the better the chances of success for Sir Alastair Morton's single-track corporate strategy of hoping something will turn up - whether it be an end to the ferry price war or compensation payments from all and sundry.

The half-year accounts yesterday produced no comfort on the revenue front, with the price war intensifying and another pounds 100m of loans agreed by the senior lenders - who are still being paid interest - to keep the company ticking over. Total cash receipts in the third quarter rose to pounds 103m, from pounds 87m in the second and pounds 74m in the first. Some pounds 91m is being predicted for the fourth quarter. Losses for the full year, including unpaid interest, could be about pounds 800m.

Things could hardly look worse. Shareholders' best hope is Sir Alastair's single- minded determination to align himself with them against the banks. Even so they are going to be lucky to salvage much from the wreckage.

Trafalgar is not out of the woods yet

Selling the Ritz is a step in the right direction, but Trafalgar House is hardly any closer to finding a way out of the woods. Its problems are as far-reaching as ever; the Keswicks must begin to believe that the very worst the Chinese could have done to them in Hong Kong would not have come anywhere near the loss they have suffered on their ill-fated diversification into Britain. Raising pounds 75m for a hotel in the books at pounds 60m is not bad, even if the buoyant state of the London tourist trade might have argued for a higher price still, but it does not change the fact that Trafalgar is a hotch-potch of businesses no one in their right mind would choose at the moment. The engineering, construction, cruises and housebuilding arms are still sucking in cash like there is no tomorrow, which means only selling the family silver can tackle the gearing problem, and there is no sign of an improvement in trading.

Chief executive Nigel Rich has used his outsider's-eye advantage well. Sending disinterested teams into all the businesses to assess their viability makes sense. It is just a shame the bid for Northern distracted management for so long during the first half of the year. Bulls of Trafalgar (they do exist) reckon that with sales approaching pounds 4bn it shouldn't be beyond the wit of man to generate a modest return even from the difficult markets the company operates in.

However, with housebuilding on its knees, construction companies unable to put together anything approaching a sensible, profitable tender, and the QE2 failing to attract the right kind of high-spending cruiser, Mr Rich is going to have to look at alternative ways of nursing Trafs back to health. It is perhaps time for less Hong Kong and more Macau, a double or quits bid by the Keswicks for the whole group would at least put the rest of Trafalgar's shareholders out of their misery.

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