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LGIM warns on French equities

08 May 2014


France is lagging behind Germany on many economic factors. Hannah Smithies reports from LGIM’s monthly Fundamentals briefing

Read more: LGIM France Germany

Legal & General Investment Management (LGIM) has expressed doubt over the French economy’s ability to catch up to that of Germany, despite the government’s recent promise of economic reform.

LGIM expects France’s GDP growth to average less than 1% over the next few years, half of that expected from Germany, and below that for Spain.

"We are not convinced that now is a good time to buy French equities over German equities," said Hetal Mehta, economist at Legal & General. "While we certainly agree that reforms are needed, we’d add that reforms must be correctly targeted in order to have the desired effect."

Germany is clearly outperforming France on most economic indicators in addition to GDP growth, including unemployment, labour cost competitiveness and fiscal policy management, confirming Mehta’s description of France as "the sick man of Europe".

Business and consumer sentiment in France has increasingly lagged behind that of Germany since 2010. France is now at a crucial juncture as public opinion has started to shift towards spending cuts and deficit reduction whilst sentiment towards President Francois Holland’s Socialist government has deteriorated.

Reforms promised by the French government include lowering taxes and creating more jobs, but have failed to include measures to create more flexibility in the jobs market, which LGIM said is an oversight.

"The inflexibility caused by the cumbersome employment laws has undoubtedly held back the French economy and contributed towards the structural shift towards higher employment," said Mehta.

France’s labour market is one of the most highly-regulated in the OECD since making significant improvements over the past 24 years, and also has highly-regulated product markets compared to many other European states.

"If you look back to 1990 France used to have one of the least regulated labour markets but now that’s turned round. France is bucking the trend to their detriment."

Unit labour cost has also risen by 30% since 2000 while only rising 11% in Germany through the same period, leading to France losing an important competitive advantage.

Mehta also said there was a need for reform in public finances: "Until 2009, France and Germany had a similar debt and deficit profile, but since then the two economies have diverged. The government has proposed a reduction in corporation tax and income tax but the details on corresponding spending cuts are still lacking."

The French government’s proposals show good intent but concrete changes to policy and more details are required in order to inspire confidence in investors.

This spells further disaster for France, which saw a 77% plunge in foreign investment over 2013 to $5.7bn (£3.5bn), the lowest level in 27 years.

While the outlook for France is negative by and large, Mehta pointed out that demographically France does has an advantage over Germany. The French population is growing much faster than Germany’s and its working age population is stable whereas Germany’s is heading downwards.

Though strong at the moment, Germany may face its own challenges in the years to come. Despite the demographic outlook it decided recently to lower retirement age.

"Germany will have to refocus on productivity gains in order to secure long-term growth and prevent an overshoot in wage and price inflation, which could eventually lead to longer-term stagnation," said Mehta.


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