France: COVID-19 ends a record of robust growth
- Despite the Gilet Jaunes and protests France was showing robust economic growth before COVID-19
- Not all sectors are equally vulnerable to the crisis, but the French economy is well-diversified
- French companies, households and banks are better equipped to weather the storm than before the Global Financial Crisis of 2008/’09
- The government has launched an extensive temporary unemployment scheme. This should prevent any mass lay-offs for now but the costs of the scheme are mounting. Unemployment will sooner or later rise, undoing the positive effects of Macrons labor market reforms
- France has had trouble reducing its budget deficit and the current crisis will cause the debt ratio to rise even further
A grim end to a success story
In recent years, the French economy showed consistent economic growth helped by a growing world economy and strong domestic demand (figure 1). Despite the Gilet Jaunes and protests over pension reforms, the French economy still outpaced most major European economies. Growth was fueled by a rise of employment (partially owing to the labor reforms of president Macron) and subsequent higher consumption. Additionally, positive business sentiment caused a surge in business investment. As is the case for virtually every economy in the world, the arrival of COVID-19 quickly turned things sour. Sentiment is now at a historic low, even surpassing pessimism during the global financial crisis (figure 2). With the recent extension of the lockdown to mid-May, it seems like the French cannot return to life as it used to be any time soon. On April 30th, the preliminary quarterly GDP figures will be released. The consensus is that there will be a contraction of around 2%. This figure does not fully contain the lockdown effect however. We expect the figures for the second quarter to be significantly worse since the lockdown will cover most of the second quarter.
For the year 2020 as a whole, we have revised our forecast from a growth of 1.1 percent to a contraction of 4.6 percent.
Vulnerable sectors of the French economy
Not all sectors are equally vulnerable for a demand and/or supply fallout. Moreover, not all sectors are equally well equipped to quickly recover to previous levels of output. The composition of the economy is therefore a key element in gauging the impact of COVID-19 and the recovery path of the economy (table 1).
Impact and recovery
We estimate that around 22 percent of the economy will be able to more or less keep up its day-to-day operations (table 1). Sectors like healthcare and financial and insurance activities fall into this category. These sectors are either vital to the economy and thus excluded from the lockdown restrictions, or these sectors can adapt to the social distancing guidelines. Once the lockdown is lifted, these companies will have few problems returning to their full capacity.
Another 53 percent of the economy will be significantly hampered by the lockdown, with an output decrease ranging between 10 and 50 percent. Companies operating in for example the agriculture or industry fall into this category. Next to the limitations imposed by the social distancing rules, these companies are also affected by disrupted supply chains or by a shortage of (migrant) workers. Once the lockdown is fully lifted (which is probably a step-wise process), most of these companies that survive the crisis can more or less return to business as usual. However, some companies will find that supply chains have been disintegrated or find other obstacles to international trade.
Lastly, sectors accounting for 25 percent of total output, will be severely hampered by the restrictions or forbidden to be open all together that they will produce less than 50 percent of what they would produce in a normal functioning economy. The hospitality and recreation sector for example have come to a complete standstill. The recovery of these sectors will take significantly longer as well. Lifting the restrictions will probably be a step-wise process and it will probably take a while before international travel is back at its pre-crisis volumes for example. And even if the restrictions are lifted, the public is probably wary of using these services.
We will evaluate the ability of sectors to operate in a so-called 6 feet economy in a forth coming piece.
The most recent data releases are a bad omen…
There usually is a substantial lag before hard data, such as the gross domestic product, is released. The (hard) data that is available so far does imply that the impact of COVID-19 is going to be substantial. Not just substantial, but the contraction is sharper than the contraction during the Global Financial Crisis. This effect can be seen from both the supply side (figure 3) and the demand side (figure 4).
Shock absorbing capacity
In times of crisis companies and households have to tap into their reserves and/or slash costs to remain solvable. For French non-financial corporates and households, reserves have increased while relative costs have declined compared to just prior to the great financial crisis (figure 5, 6).
This means that, generally speaking, business and households are in a better position to deal with temporary cash flow issues stemming from disruption in trade, supply chains or a loss of income.
As such, the risk of financial factors aggravating the shock in the short run is likely to be smaller than in 2008/’09. Yet the shock is more severe than during the financial crisis and unequally distributed among firms. Furthermore, cash reserves are unequally distributed between companies. The French government is determined to provide liquidity to otherwise healthy companies that are short on cash to prevent them from going bust. But it still seems inevitable that some business will go bankrupt. Yet it is difficult to estimate how many. In any case, the longer the lockdown is in place, the higher the risk of the shock feeding into the financial system.
A lesson learnt from the Global Financial Crisis is that financial institutions should not stretch their leverage ratios too much. To solidify the balance sheet of banks the European Banking Authority has ramped-up capital requirements through the Basel accords. Capital and reserve positions have thus improved significantly (figure 7). At the same time, NPL ratios have improved significantly on the back of robust economic growth in the past years (figure 8). So we can safely say that French banks are in a better position to weather the storm than they were prior to the previous crisis. Nonetheless, a period of prolonged economic stress or failure of the government to support businesses could increase the number of non-performing loans in a glimpse.
President Macron started his presidency with ambitious plans to reform the labor market. To his success and on the back of global economic growth, this has resulted in a significant decrease of the unemployment rate (figure 9). Now that France is struck by COVID-19 it is evident that the unemployment rate will rise. The question is, to what level?
As an indication of what we can expect for unemployment levels, we can look at the Global Financial Crisis. During the crisis of 2008/’09 the French economy contracted by 2.7%. Meanwhile, the unemployment rate rose from 7.1 percent to 9.1 percent. If we can compare both crises, we can expect the unemployment rate to increase from 8.0 to 11.5 percent. This of course, is not a sophisticated economic approach but it gives some idea about the magnitude of the change.
A difference with the Global Financial Crisis is that France did not employ a massive short-time working scheme and the shock France is experiencing right now is sharper but most likely short-lived. Right now, the French government is sparing no efforts to ensure that massive lay-offs are avoided through the adoption of the so-called Temporary unemployment scheme. This scheme pays employees of affected companies 84% of their net wage with a maximum of 4.5 times the minimum wage.
The demand has been huge so far. As much as 700.00 companies and 10.2m employees have applied for the scheme. If these people were fired (luckily, it is unlikely that all 10.2m employees would lose their job) unemployment would rise to 43%. These figures remind us of the Great Depression.Consequently, due to the huge demand, the costs of the program are much higher than anticipated; currently the costs are around three times the initial estimated of EUR 8bn. To stop the spiraling expenses of the program the French labor minister, Muriel Pénicaud, requested the CEOs of big French companies to step out of the program, to show ‘civic behavior for the collective good’.
Pressure on the welfare state could rise even further however. If the lockdown is extended or the recovery takes longer than expected, companies could be force to fire more employees. Especially employees with a temporary contract and the self-employed are vulnerable. This could lead to another surge of unemployment benefit claims (figure 10).
The final effects on unemployment thus depend on a number of variables, amongst others the length of the lockdown and the ability of the government to sustain their temporary unemployment scheme. Unemployment rates in their turn will partly determine the pace of recovery. If companies do not have to rehire and retrain employees, the recovery can be much faster.
At 98.1 percent of GDP, France’s debt ratio is currently vastly above the threshold of 60% agreed upon in the Maastricht treaty. And the government has made little progress in reducing the debt burden since its significant rise after the financial crisis (figure 11). Despite the historically low interest rates on government debt (figure 12), the French government has not been able to end the year with budget surplus for the past 45 (!) years. The latest primary surplus, i.e. when excluding interest payments from the total budget balance, dates back to prior to the financial crisis. Recent attempts to narrow the budget deficit were unfruitful; the Gilet Jaunes and the pension reforms protests forced president Macrons hand to widen the deficit.
It is evident that COVID-19 will force Macrons hand to spend even more. The aforementioned temporary unemployment scheme is just one of the many expensive policies that is necessary to keep the French economy afloat. Additionally, there is a package of EUR 300bn of government backed loans and a package of EUR 45bn (including the temporary unemployment scheme) in measures such as tax deferrals and direct subsidies. In the (very) optimistic scenario that the measures that have been announced so far will prove to be sufficient to dampen the shocks of the lockdown enough to prevent large scale bankruptcies and unemployment. In addition to these costs, there will still be need for a significant amount of spending to speed up the recovery process afterwards.
Based on our economic projections, the announced fiscal stimuli, and budget elasticities, i.e. automatic stabilizers, we project a debt ratio of 111% for 2020.
If costs for stimulus packages turn out to be higher than expected or if the lockdown is extended this figure could be significantly higher.