Head of Macro Analysis, Saxo Bank Group
Summary: The French "yellow vest" movement continues to call for further protests, and the Macron government's ability to meaningfully address its concerns appears limited.
According to all polling institutes, the movement enjoys massive support from the population, between 70% and 80%.
Say goodbye to deficit reduction
The government has two main options to finance the cost of the tax delay. The first option would be to increase the public deficit. The deficit forecast for 2019 is at 2.8%, which represents €66.7bn. A 3% deficit, which is the limit allowed by European treaties, is equivalent to €71.6bn. Therefore the government’s fiscal leeway is about €4.9bn. Since the tax delay will cost around €2.5bn, the government could decide to finance this measure by slightly increasing the deficit while remaining under the 3% line. It would still have a fiscal cushion of €2.4bn before reaching this symbolic threshold.
It is not that easy, however, as to reach its deficit projection, the government is counting on GDP growth of 1.7% next year, which seems overly optimistic. In theory, a slowdown in growth of 0.1 percentage points leads to an average deficit increase of 0.06 percentage points of GDP. Concretely, if growth is between 1.4% and 1.5%, as we realistically anticipate, the French public deficit will not be at the planned 2.8%, but at 2.98% – just below the permitted threshold.
The risk is extremely high that if the government chooses this option, there will be long and tough negotiations with the EC once everyone realises that the official growth forecast is not aligned with hard economic data.
The second option would be to revoke the reduced VAT rate for restaurants and again apply the reference rate of 19.6%. This measure was initially aimed at reducing bills for clients and creating jobs in the sector, but it has been very inefficient. The loss for the state in terms of tax revenue is around €3.6bn/year and there are still nearly 100,000 unfilled jobs in the hotel and restaurant sector. This would be quite easy to implement with a rather limited negative effect.
Little macro and market impact so far
So far, it is difficult to estimate the real macroeconomic impact of the movement, but it will certainly lead to lower GDP growth in Q4 and, if it continues, we should expect very ugly figures in Q1 2019. Investors still seem confident, however, regarding French assets. The CAC 40 index has showed resilience over the past few days due to the strong performance of export companies’ stocks. However, if there is again an atmosphere of civil war on Saturday, foreign fund managers will grow uneasy, especially Japanese investors who could drastically reduce their purchases of French sovereign bonds (as was the case just before the 2017 presidential election).
The government has waited too long before addressing the demands of the gilets jaunes. To appease protesters, it will need to announce strong symbolic measures such as the reinstatement of the wealth tax or measures that will have a visible impact on purchasing power.
The most obvious and easiest option could be to reestablish the wealth tax. An evaluation of the impact of the cancellation of the wealth tax on investment is planned for the fall of 2019. There are two main issues: the first is that the timeframe between cancellation and evaluation is far too short to know the real impact. The second one is that it is impossible to know how the capital that should have been taxed under the wealth tax has been used.
We are unable to know whether this cancellation has really benefited investment in the real economy, as expected by the government. Since the reestablishment of the tax on wealthy people is a strong demand of the movement, and since it could have a rather limited negative impact on the economy, this option seems quite likely. However, it would clearly stop reforms in France and it would symbolise the premature end of Macron’s presidency.
The other oft-discussed option is to increase the minimum wage, but this would have a very negative consequence on the French labour market. As part of the economic recovery of 1981, the government had decided to increase minimum wage by 6.4% per capita, which contributed to a jump in the unemployment rate from 5.6% in 1981 to 6.9% in 1983 despite higher GDP growth.
Subsequently, and when faced with the failure of this economic policy, the government was forced to opt for austerity measures. A similar decision would have almost identical negative effects and would lead to higher unemployment rate. It seems risky for the government to implement such a measure; it would represent economic suicide.
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