The French government must prevail in its efforts to trim public pension and welfare costs, or risk plunging France into a financial crisis and possibly scuttling a single currency in Europe, investment experts warned.
"We really are at a turning point in France," said Frederic Jolly, managing director of Frank Russell Co.'s Paris office. "People understand that we have to re-engineer the public sector and the state."
Despite strikes by rail workers, students, public workers and employees of state-owned companies, many investment managers think the Chirac government must win its struggle to reduce the government deficit.
The stakes simply are too high for the government to lose, managers argue, although some compromises may be made.
A retreat by the government could set off a financial crisis in France, causing the franc to plunge. What's more, it would prevent France from meeting the Maastricht Treaty criteria for participating in a single European currency - a prospect that could doom European monetary union and could cause currency turmoil throughout Europe.
The French government will have to persevere because "the alternative is impossible," said Consuelo Brooke, a director at Mercury Asset Management PLC, London. If the government were to back down, "they're dead meat," she said.
A government retreat would precipitate a financial crisis, said Jean-Pierre Hellebuyck, president director general of AXA Asset Management, Paris.
Prime Minister Alain Juppe has taken on a host of constituencies in one fell swoop, the biggest being recipients of state-provided pension and welfare benefits. The annual cost of taxes and social costs combined equal a staggering 45% of gross domestic product.
In his budget, Mr. Juppe proposed eliminating the state system's 60 billion franc deficit ($12 billion) within two years. To do this, he proposed shifting cost controls on health care away from unions, who run the system, into the hands of the French Parliament - a clear threat to a major union power base.
Mr. Juppe proposed an additional 0.5% income tax to help pay off the social security system's 230 billion franc ($46 billion) debt, and endorsed higher health-care contributions for retirees and the unemployed.
As a long-term measure, he proposed requiring France's 5 million public sector employees to work for 40 years before retiring with a full pension, instead of 37.5 years now.
Lengthening the service period for retirement upset unions, particularly in the rail sector, where workers can retire as early as age 50.
What's more, a proposal to restructure the SNCF - Societe Nationale des Chemins de Fer, France's national rail system - threatens to eliminate thousands of railway jobs and close about one-sixth of its 32,300 kilometers of track. A government offer to assume 37 billion francs of the SNCF's 175 billion franc ($35 billion) debt was rejected by railway workers, who led the strike that started Nov. 24.
Meanwhile, prospects of partially privatizing France Telecom further antagonized workers there. Telephone, postal, electricity, gas, airline, police, educational and hospital workers - who are covered by special state-run pension plans with generous benefits - since have joined the strike, although the action has not spread to the private sector.
Mr. Juppe insisted last week he will stick with his plan to reduce France's budget deficit to 3% of GDP by 1997 from 5% now.
But if Mr. Juppe caves in, France would fail to qualify for European monetary union in 1999. If that happened, the franc and French stocks and bonds could take a beating, as the Banque of France likely would be forced to boost interest rates to defend the franc. Short-term rates already are at 5.7%, despite inflation below 2%, and unemployment is hovering at 11.5%.
If EMU fails, spreads on 10-year French government bonds over 10-year German bunds could nearly double to about 150 basis points from 80 basis points currently, said James Lister-Cheese, a strategist with Independent Strategy, London.
Mr. Lister-Cheese said he is "pretty cynical about the ability of the French administration to push through deficit reduction" in the two years offered to meet Maastricht guidelines, even if the government's program is adopted.
Like most forecasters, he thinks the government's projected economic growth rate of 2.8% for 1996 is extremely optimistic. "I wouldn't be surprised if it came in at 1% next year," he said.
That will generate a shortfall in revenue. In addition, debt-servicing costs have been underestimated, he said. Mr. Lister-Cheese projects France's deficit will be 4.4% of GDP in 1997 - well above the 3% limit imposed by the Maastricht Treaty.
Meanwhile, French economic indicators are plunging, and are being worsened by the strike. "I am very concerned that the economy is falling down like a stone," said AXA's Mr. Hellebuyck. If it does, next year's budget will be more difficult, he said.
Still, some money managers hold out hope for French equity and bond markets. European equity managers had an average of 14.6% invested in French stocks as of Sept. 30, 200 basis points above the Morgan Stanley Capital International Europe index, according to The WM Co., Edinburgh.
For the short term, markets are likely to be rocky, money managers said. "In the midterm view, the government will get it right. It will resist the claims of the strikers and is very committed to public pension reform and participation in EMU," said Peter Dencik, managing director of Singer & Friedlander International Asset Management Ltd., London.
Some stockpickers have found the best buys in midsized stocks, staying away from CAC-40 index stocks, which are dominated by financial firms.
Since April 1993, the CAC-40 has lost 11.5% in local terms, while the Financial Times-Actuaries Europe ex-U.K. index has gained 25.8% in local terms, noted Mark Lloyd-Price, director of European equities for Lombard Odier Investment Management Services Ltd., London.
London-based Global Asset Management Ltd. has about 25% of European equity portfolios invested in French stocks, about twice the benchmark level. But only one-third of that exposure is held in CAC-40 stocks, explained John Bennett, head of European equities.
The rest is invested in midsized stocks with good earnings growth.
But he sees little point in buying CAC-40 stocks, many of which are more focused on building assets than earnings. Unless interest rates drop on the order of 250 to 300 basis points, they won't help the big stocks, Mr. Bennett said.