Macron Bets Spending Binge Can Save His Plan to Transform France

(Bloomberg) -- Emmanuel Macron is rolling the dice with France’s public finances to keep his grand plans for the economy alive after weeks of protests on the streets.

Macron’s government will set out a raft of measures to try to calm the so-called Yellow Vest protests on Thursday and they will almost certainly see France breach the European Union’s budget deficit ceiling next year.

The 40-year-old president is arguing the concessions are necessary to maintain public support for his efforts to make the economy more efficient.

“Macron is now facing an impossible trilemma," said Bernhard Bartels, associate director at Frankfurt-based Scope Ratings. "You can’t have have popular support, ongoing structural reforms and fiscal consolidation all at the same time.”

Macron’s announcement Monday that he’ll raise the minimum wage, abolish taxes on overtime, and get rid of a controversial tax on pensions will send next year’s budget deficit to about 3.5 percent of output, up from a previous target of 2.9 percent, according to media reports. That’s well beyond the 3 percent limit imposed on members of the euro zone.

France’s 10-year spread over German bunds, a gauge of political risk, this week reached its widest since Macron took office in May last year.

Macron’s Argument

Prime Minister Edouard Philippe will give full details of the 2019 budget in parliament when the government faces a no-confidence vote called by a small group of leftist parties. The vote has no chance of success but will force the government to set out its spending plans.

France’s change of tack on the budget brought angry outburst from the Italian government, which is facing unprecedented pressure from the European Commission to keep its deficit next year below 2 percent. A European Union summit this Thursday and Friday isn’t scheduled to take up the issue of either country’s deficit, but a close aide to Macron said he’s ready to make his case.

Macron’s argument, the official said, is that the new spending burst doesn’t put into doubt the changes he’s already made to labor law, taxes, and the national rail company. And it won’t deter him from simplifying France’s pension system. But those reforms will be in danger if he doesn’t douse the month-old Yellow Vest protests.

Macron is risking a temporary confrontation with the European Commission -- and an uptick in France’s borrowing costs -- to push on with the rest of his reform program. He’s staked his presidency on transforming France so that it can compete on the world stage.

“Given past achievements in taxation and on the labor market, a partial compensation for low-wage earners seems warranted in order to prevent further damage to the economy and, in the worst case, a collapse of the government,” Bartels said.
EU Commissioner for Economic Affairs Pierre Moscovici signaled that officials in Brussels may be receptive to Macon’s arguments. He said he believes that unlike Italy, France’s budget deficit breach may only be temporary.

“He has turned from darling to fallen angel very quickly," Kallum Pickering and Florian Hense at Berenberg said in a research note. All the same, "he is taking the right approach to address the protesters’ concerns. He gives out hand-outs -- which risks inflating the fiscal deficit -- but does not backtrack his supply-side reforms.”

What Our Economists Say...

“The fiscal loosening shows that France’s embattled president is more worried about Yellow Vests in Paris than gray suits in Brussels, whose fiscal rules are being broken. The danger is that the protests continue anyway because too much of the giveaway is targeted on pensioners and not enough on those in work.”

-- Maeva Cousin, Bloomberg Economics 

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