EurozoneEY Eurozone Forecast September 2013

AustriaBelgiumCyprusEstoniaFinlandFrance

GermanyGreeceIreland

ItalyLuxembourg

MaltaNetherlands

PortugalSlovakiaSlovenia

Spain

Spain

Portugal

France

Ireland

Finland

Estonia

Belgium

Slovakia

Austria

Slovenia

Italy

Greece

Malta Cyprus

Netherlands

Luxembourg

Germany

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Outlook for France

Lowest corporate margins for decades will restrain growth

Spain

Portugal

France

Ireland

Finland

Estonia

Belgium

Slovakia

Austria

Slovenia

Italy

Greece

Malta Cyprus

Netherlands

Luxembourg

Germany

1EY Eurozone Forecast September 2013 | France

Highlights

• Recent developments have confirmed our view that the French economy returned to growth in mid-2013, with GDP rising 0.5% in Q2. A slowdown in the pace of fiscal tightening will enable growth to pick up from 2014, but low corporate margins and high and ongoing job losses will constrain the pace of the recovery.

• After expected GDP growth of 0.3% in 2013, we forecast expansion of 1% in 2014. From 2015, growth will pick up gradually as companies restore profitability and foreign demand accelerates. We expect growth to average about 1.3% a year in 2015–17.

• At under 35% in Q1 2013, the corporate margin to value-added ratio was at its lowest since the early 1980s. Looking ahead, these low margins will constrain firms’ ability to invest, despite favorable external financing conditions. As a result, we do not expect business investment to reach its pre-crisis peak for the next five years.

• We forecast further increases in unemployment until early 2014, as firms restructure payrolls to restore profitability. We forecast the unemployment rate to peak at 11.3% in Q1 2014, before edging down slowly, but it will not fall below 11% until 2016.

• Inflation of under 2% over the next five years will only partly offset the unfavorable developments in the labor market. Overall, we forecast households’ disposable income in real terms will increase by only 0.5% in 2014 and by 1.2% a year in 2015–17. This is around half the pace of the growth seen in the 10 years prior to the global financial crisis.

• The recovery will gather pace as companies improve their profitability and are able to invest and hire again. A gradual acceleration in foreign demand will also contribute to a better economic environment. Exports have disappointed this year and volumes will probably be flat in 2013 as a whole. However, we expect them to rise by about 3.1% in 2014, and then by 4.5% a year in 2015–17.

GDP growth

2013

0.3%

Unemployment

2013

11%

Exports of goods and services growth

2013

1%

GDP growth

2014 1%

2 EY Eurozone Forecast September 2013 | France

Lowest corporate margins for decades will restrain growth

Growth of 0.5% seen in Q2 …

As we had expected, the French economy returned to growth in Q2 2013, with GDP posting a 0.5% rise on the quarter. In particular, the industrial sector recouped some of the production losses experienced at the beginning of the year — echoing a pattern seen across the Eurozone. The improvement was also reflected in business surveys such as the Purchasing Managers’ Index (PMI). In August, the services and manufacturing components of the index were close to the threshold (50) that separates expansion from contraction.

… and less fiscal tightening will support growth

Consistent with the current levels of orders and business confidence, we forecast slightly positive GDP growth in the second half of the year. For 2013 as a whole, GDP should expand by 0.3%.

A slowdown in the pace of fiscal tightening will allow growth to resume from 2014 onwards. Indeed, while fiscal tightening has subtracted around one percentage point a year from GDP growth in 2011–13, we expect the fiscal drag will be reduced to 0.5 percentage points a year from 2014, based on the measures announced so far. In particular, businesses’ costs will be significantly reduced by the tax rebate reaching full scale. We also think that public

investment cuts will be lower than in the last few years, which will have a direct positive impact on economic activity.

New short-term fiscal objective is achievable

The revised short-term objective of reducing the budget deficit to 3% of GDP by 2015, from 4.8% in 2012, is achievable and in line with our forecast. This has been endorsed by the European Commission, giving some credibility to France’s fiscal policies.

However, the medium-term objective of a balanced budget by 2017 would need significant additional tightening measures. We do not think that these measures will be implemented, but, as long as the aim of narrowing the budget gap is sustained,

France (annual percentage changes unless specified)2012 2013 2014 2015 2016 2017

GDP 0.0 0.3 1.0 1.2 1.3 1.4

Private consumption –0.3 0.4 1.0 1.1 1.2 1.3

Fixed investment –1.2 –2.2 0.6 1.4 1.9 2.0

Stockbuilding (% of GDP) –0.2 –0.1 0.0 0.1 0.0 –0.1

Government consumption 1.4 1.5 0.6 0.6 0.7 0.9

Exports of goods and services 2.5 1.0 3.1 4.2 4.7 4.9

Imports of goods and services –0.9 0.9 3.1 3.8 4.1 4.1

Consumer prices 2.2 1.1 1.6 1.5 1.4 1.4

Unemployment rate (level) 10.3 11.0 11.2 11.1 10.9 10.7

Current account balance (% of GDP) –2.2 –1.5 –1.4 –1.5 –1.4 –1.2

Government budget (% of GDP) –4.8 –3.9 –3.3 –3.0 –2.6 –2.2

Government debt (% of GDP) 90.3 94.0 96.8 99.8 101.7 102.4

ECB main refinancing rate (%) 0.9 0.6 0.5 0.5 0.5 0.7

Euro effective exchange rate (1995 = 100) 115.5 119.4 117.7 114.1 112.8 112.1

Exchange rate ($ per €) 1.28 1.31 1.24 1.19 1.18 1.18

Source: Oxford Economics.

3EY Eurozone Forecast September 2013 | France

financial markets are unlikely to respond negatively to a slightly higher deficit than planned. We forecast it at about 2% of GDP in 2017, but we think that this will not trigger a significant widening of the spread between French and German government bond yields, which are likely to rise gradually over the next five years as growth accelerates.

Businesses will need to restore profit margins …

However, less fiscal tightening will not be enough to ensure robust growth, because other obstacles remain, and so we expect GDP growth of just 1% in 2014. A particular impediment to higher growth is the currently very low level of corporate margins. At less than 35% in Q1 2013, the corporate margin to value-added ratio was at its lowest since the early 1980s.

Margins have been eroded by low productivity growth and ongoing increases in wage costs. Unless they can be rebuilt quickly, which seems unlikely in a muted economic environment, low margins will constrain firms’ ability to invest by restricting internal finance. And although external financing conditions are favorable, companies are likely to focus on restoring profit margins at the expense of investment projects in the short term.

As a result, we do not expect business investment to reach its pre-crisis peak within the next five years. Low investment will be a significant drag on overall growth.

… which may involve further job losses

Restoring profit margins is likely to involve further job losses, as companies are still reforming the way they produce goods and services in order to achieve more efficient processes. These job losses will be only partly offset by job creation as the result of the Government’s employment program. In July, the Government announced an extra 10,000 jobs in the education sector would be created by September 2013. But experience suggests that, in the private sector at least, subsidized jobs are partly used by companies that would have employed people even without government help. For 2013, 100,000 emplois d’avenir targeted at the under-25s were planned. However, in June, the unemployment rate among this age group was still very high, above 25%. We expect the jobless rate to peak at 11.3% in Q1 2014, before edging down slowly, but the rate will not fall below 11% until 2016.

Figure 1PMI

Index

30

40

50

60

70

1999 2001 2003 2005 2007 2009 2011 2013

Services PMI

Manufacturing PMI

Source: Haver Analytics, Markit.

Figure 2Corporate margins

Margins to value-added ratio, %

20

25

30

35

40

45

50

55

60

1950 1960 1970 1980 1990 2000 2010

Source: Institut national de la statistique et des études économiques.

4 EY Eurozone Forecast September 2013 | France

Lowest corporate margins for decades will restrain growth

Figure 3Unemployment

Forecast

7

8

9

10

11

12

1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017

%

Source: Oxford Economics.

Figure 4GDP growth: France vs. rest of Eurozone

Forecast

% year

–8

–6

–4

–2

0

2

4

6

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

France

Other Eurozone

Source: Oxford Economics.

Households must adjust to low gains in purchasing power

High unemployment will weigh on households’ ability and willingness to spend. Wage increases have so far been relatively resilient to the rise in the jobless total, but earnings growth is likely to slow over the coming year as high unemployment persists. However, this will happen in the context of relatively low inflation, which will help preserve purchasing power. We forecast consumer price inflation will stay below 2% throughout the forecast horizon, as companies cannot push through price increases in an environment of subdued demand.

Overall, we expect households’ disposable income to increase by 0.5% in 2014 and 1.2% a year in 2015–17, around half the pace seen in the 10 years prior to the global financial crisis.

Recovery to receive boost from foreign demand …

The recovery will gather pace as companies improve their profitability and are able to invest and hire again. GDP growth is expected to average 1.3% a year in 2015–17.

A gradual acceleration in foreign demand will also contribute to an improving economic environment. Exports have disappointed this year and volumes will probably be flat in 2013 as a whole, but we think export volumes will rise by 3.1% in 2014 and by 4.6% a year in 2015–17. Initially, the revival in foreign demand will mainly stem from the US and, to a lesser extent, emerging markets. But, as global trade picks up, the whole of the Eurozone will benefit and France’s exports to its neighbors will accelerate too.

… but contrasting performance across sectors

Economic performance across sectors is likely to vary significantly. While for the economy as a whole the level of value added is forecast to be 7% higher in 2018 than before the global financial crisis, the manufacturing sector is not expected to have risen at all during this period and the construction sector is forecast to be nearly 10% smaller. By contrast, some sectors are set to experience robust growth, despite the challenging environment. These are typically services sectors that have managed to adjust to new demands and work practices. Communication and professional services stand out, with value added expected to be 20% higher by 2018 than in 2007.

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Other EY publications

• Rapid-Growth Markets Forecast • EY Eurozone Forecast: Outlook for financial services

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