Photo: Mary Margret on Flickr
With its AAA rating under fire and the future of the European Financial Stability Facility in question, vultures are now circling around France.The yield on French 10-year bonds over German bunds has been shooting up recently, and a battle is taking shape between France with much of the rest of Europe and team of Germany and the European Central Bank over whether eurobonds could mitigate mounting borrowing costs on sovereign debt in the near term.
As it stands, France’s banks have high exposure to Italian sovereign debt and the French government has no access to European Central Bank resources to stem borrowing costs.
Although France is generally regarded as one of Europe’s stronger economies, the loss of its AAA rating would be devastating to European efforts to build a firewall that would prevent contagion from spreading through the EU banking system.
Right now, France's gross public debt amounts to some €1.7 trillion ($2.3 trillion), or 87.4% of GDP. That's the highest ratio of debt-to-GDP of any AAA-rated country in the euro area.
Source: Der Spiegel
High costs of employing workers makes doing business expensive — particularly in comparison to neighbouring Germany.
Italian borrowers owe French banks some $366 billion. That's on top of the $53.9 billion Greek borrowers of them.
With Italy under fire and PM Mario Monti aching to get his country's debt under control, the possibility that French banks might have to write down some of their Italian assets is looking increasingly likely.
Source: New York Times
The French government has said that could revise growth targets downwards from the 1.75% it previously predicted for the year.
Sarkozy has dismal approval ratings -- around just 35%.
Although he knows that budget cuts are in order, it could be difficult to choose between making unpopular spending cuts and the eliminating the tax loopholes that have made him the darling of the business elite.
In a speech today, he and Finance Minister Francois Baroin also refused to cut more jobs from state-owned companies.
Source: Reuters and Bloomberg
Sarkozy and German Chancellor Angela Merkel have already ruled out European Central Bank help in recapitalizing European banks. If French banks cannot raise money to meet the required 9% core 1 capital to liabilities ratio, they will have to call upon the French government.
This would probably put further strain on France's already significant debt burden, as the country will probably not be able to access more funding from the eurozone rescue fund, the European Financial Stability Facility.
Merkel won an important battle for Germany when she put an end to Sarkozy's hopes that the ECB could be involved in bank recapitalization.
While that outcome was not unexpected -- Sarkozy's plan likely violated EU treaties -- France's interests still lost out to Germany's.
rumours circulate that it could soon put the country on downgrade review.
The deterioration in debt metrics and the potential for further contingent liabilities to emerge are exerting pressure on the stable outlook of the government's Aaa debt rating. Moody's notes that the French government now has less room for manoeuvre in terms if stretching its balance sheet than it had in 2008. France's continued commitment to implementing the necessary economic and fiscal reform measures as well as visible progress in achieving the targeted sustainability improvements will be important for the stable outlook to be maintained.
The French government's AAA rating is closely tied with its obligations to banks and the EFSF. Bigger obligations to either organisation could put it in jeopardy.
France is responsible for 20.4% of funds available to the EFSF. If downgraded, the rating of that contribution will also fall, vastly reducing the EFSF's capacity to insure debt and lend money.
That could completely derail EU leaders' plans to prevent contagion from spreading throughout the eurozone.
France and its debt remain stable, but borrowing costs have been shooting up and 10-year yields hit 3.55% today.
Unlike Italy and Spain, France is not part of the Securities Market Programme--the plan which allows the European Central Bank to mitigate rising bond yields by purchasing debt on the secondary market.
If the yield on French debt and the cost of insuring it continue to rise, fears about rising borrowing costs could be self-fulfilling. The bigger the worry, the higher the cost of French borrowing, which will generate even more fear in the markets.
French leaders--including Finance Minister Francois Baroin--have stepped up their support for joint eurobonds, which would allow all 17 eurozone countries to guarantee the repayment of sovereign bonds.
The official German government and ECB line has been positioned firmly against these ideas, and this squabble appears to rapidly be turning into a shouting match.
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