By Jack Duffy

PARIS (MNI) – The likely election of Socialist Francois Hollande as
France’s next president would bring tougher international scrutiny on
the country’s weak finances, raising the risk that Paris could be the
next target of Europe’s debt crisis.

With financial markets already jittery that Moody’s is about to
strip France of its AAA credit rating, the spread between French and
German 10-year bonds widened to a three-month high of nearly 150 basis
points on Friday. Analysts say the probability of more political
posturing in the run-up to parliamentary elections in June could roil
the markets even more.

“This is a potentially very dangerous situation that could be
damaging for the markets,” warned UBS economist Stephane Deo in a note
to investors.

The danger for France could be even greater longer term as
investors scrutinize Hollande’s plans for more spending and higher taxes
against the background of a weak economy, high unemployment and a debt
profile that increasingly has more in common with peripheral Eurozone
countries than with the core.

“France has to work harder at economic reform,” said Luca Jellinek,
head of European rates strategy at Credit Agricole CIB. “If you are
looking three to six months down line, whoever is president is going to
have to put in place something that convinces the market.”

To be sure, Hollande has pledged to stick to nearly the same
budget-cutting path as the outgoing president Nicolas Sarkozy, balancing
the budget in 2017 as opposed to 2016 under Sarkozy’s plan.

But other major parts of his economic plan — raising taxes on
major companies and high earners, increasing social welfare payments,
seeking to renegotiate the EU Fiscal Compact on budget discipline —
appear to go in the other direction.

And Hollande has failed to address at all the issues that most
preoccupy economists and rating agencies: France’s high labor costs and
declining competitiveness, rising trade and current account deficits,
and the highest rate of public spending in the Eurozone.

“Concern about Hollande may be more to do with medium-term issues
like France’s loss of competitiveness compared to Germany,” said
Dominique Barbet, an economist at BNP Paribas. While Sarkozy made
comparisons with Germany a big part of his argument for reform,
“Hollande has made it clear he will not go down that road,” Barbet said.

Hollande, who is largely unknown outside of Europe, would be the
country’s first Socialist president since Francois Mitterrand’s second
term ended in 1995. He has never held a senior ministerial post and has
little experience in international financial affairs.

His major international initiatives, renegotiating the Fiscal
Compact and making economic growth part of the mandate of the European
Central Bank, are expected to be firmly blocked by Germany.

But Hollande, who during the campaign said he was the “enemy of
finance,” is going to have take a softer line after he is elected. With
nearly two thirds of France’s E1.3 trillion of negotiable debt held by
foreign investors, more anti-capitalist rhetoric once he is in office
could cause spreads to widen further as more foreign bond holders
depart.

Non-resident holdings of French debt have already declined from
71.4% in mid-2010 to 65.4% at the end of last year, as the debt crisis
has made foreign investors wary of the Eurozone. Wider spreads would add
to debt service costs, which at an expected E48 billion this year, are
already the government’s second largest budget item after education.

“Bond markets are not good at drawing fine distinctions between
candidates in an election,” said Jellinek of Credit Agricole. “But after
the election there will be a lot of sustained attention and the risk for
France will be much higher.”

–Paris newsroom, +33142715540; jduffy@marketnews.com

[TOPICS: M$$CR$,M$X$$$,M$F$$$,MT$$$$,MGX$$$]