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French presidential election: Hollande victory detrimental but no game changer

The latest polls for the second, decisive round of the French presidential election on May 6 give Francois Hollande around 56 per cent of the votes, implying that he will become the next French president. In our opinion, a Hollande victory would be detrimental to French public finances but no game changer; the differences between Hollande and Sarkozy regarding public finances should not be exaggerated. Besides, bond markets will force the next president to adopt a tough approach to the countrys budget deficit. However, the FrancoGerman understanding on the need for euro zone austerity would be in jeopardy with several of Hollandes proposals anathema to Germany. So far, French voters economic concerns have been met with various business unfriendly campaign proposals. At the same time, no discussion has taken place to formulate a strategy to reform the uncompetitive French economy. Its financial sector in particular is likely to suffer from increased taxes and additional regulations.
SARKOZY VS HOLLANDE. The French Presidential election has caught the interest of investors due to its potential effects on the countrys public finances, its banking sector and its relationship with Germany including the wider implications for EU policies. The election will be decided over two rounds, barring the highly unlikely event that a single candidate achieves a majority of the votes in the first round scheduled for April 22 (something which has never happened). The two candidates securing the largest share of votes in the first round compete in the second, decisive round scheduled for May 6.

FRIDAY 20 APRIL 2012

Although a total of 10 candidates have qualified for the first round, it would be extremely surprising if it did not result in the two expected candidates, Nicolas Sarkozy, the incumbent president representing the centre-right UMP party and Francois Hollande, representing the Socialist party, facing off in the second decisive round. At the end of this Insight we include profiles of the three candidates trailing Sarkozy and Hollande. HOLLANDE AHEAD IN THE POLLS. Currently, opinion polls suggest Hollande will be the next French president. First round polls show that Sarkozy has lost ground recently and that Hollande is ahead. However, more importantly, Hollandes support has exceeded that of Sarkozy in second (decisive) round polls since November 2010, to the extent that the market has probably already discounted a strong probability of a Hollande victory. The three latest polls show Hollande winning a clear majority of votes in the second round.

Sarkozy is a deeply unpopular president with his approval ratings below 40 per cent. However, Hollande generates more ambivalence than passion among leftleaning voters, encouraging resignation rather than the euphoria that characterised Francois Mitterands campaign in 1981. Significantly, the eventual abstention rate could exceed 30 per cent.
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This report is produced by Skandinaviska Enskilda Banken AB (publ) for institutional investors only. Information and opinions contained within this document are given in good faith and are based on sources believed to be reliable, we do not represent that they are accurate or complete. No liability is accepted for any direct or consequential loss resulting from reliance on this document Changes may be made to opinions or information contained herein without notice. Any US person wishing to obtain further information about this report should contact the New York branch of the Bank which has distributed this report in the US. Skandinaviska Enskilda Banken AB (publ) is a member of London Stock Exchange. It is regulated by the Securities and Futures Authority for the conduct of investment business in the UK.

Economic Insights

HOLLANDE VICTORY NO GAME CHANGER FOR FRENCH PUBLIC FINANCES. The policy differences between Sarkozy and Hollande regarding public finances should not be exaggerated. Both embrace deficit reduction although they seek to do so mainly through tax increases rather than through less growth toxic spending cuts. Hollande aims to balance public finances by 2017, one year later than Sarkozy and wants tax increases to play an even greater role in place of spending reductions. Hollande also demands changes to the EU fiscal discipline treaty to include provisions to promote growth, potentially delaying the ratification process. Whoever wins the election will be forced by bond markets to adopt an uncompromising approach to the deficit; any major change in policy to ease austerity will be swiftly punished by rising bond yields. Sarkozy would need to find additional budget savings while Hollande would be forced to abandon some spending plans. Neither candidate has prepared the voters for the fact that many campaign promises will need to be either compromised or scrapped. ELECTION CAMPAIGN LACKS REFORM AGENDA. Surveys indicate that economic issues are the main concern of French voters with unemployment and wages of greatest significance. Issues regarding national security, highlighted by the Toulouse terrorist shootings, are relatively unimportant to the French electorate. Unfortunately, voters economic concerns have been met with proposals generally hostile to business with both Sarkozy and Hollande announcing several policies to increase taxes but very little in the way of economic reforms to improve competitiveness and stimulate economic growth. Hollande has announced a top marginal income tax rate of 75 per cent on annual incomes above EUR 1.0mn. Including other charges, the top marginal rate may exceed 90 per cent. Corporate taxation of the financial sector will increase to almost 50 per cent; stock options will be outlawed; and bonuses capped. Hollande will also seek to increase the annual wealth tax and raise the minimum wage. Sarkozy has proposed a new tax on foreign sales by French multinationals. Several major French banks are said to already be exploring possible disinvestment options, relocating all or part of their operations overseas. Current campaign proposals look set to reinforce their willingness to do so. For example, French firms are already struggling to hire foreign employees. Investment banks and international law firms would be especially liable to move abroad given their relatively high mobility.

A Hollande presidency would have several similarities to President Mitterrands victory in 1981, and is perceived to be as negative by the markets. For example, the election follows a long period of austerity. Also, Hollande has declared the financial sector an enemy and opposes a global policy consensus on austerity. However, most proposals with negative implications for business would take effect in the long run rather than the short term. Just as problematic is the fact that neither Hollande nor Sarkozy are discussing how (or indeed whether) they intend to resolve Frances fundamental, longer-term problems, including weak competitiveness, slow economic growth, and large scale state-influence (public spending accounts for 56 per cent of GDP). The proposed measures do nothing to address these problems. France needs a comprehensive strategy for economic reform and neither Sarkozy nor Hollande are able or willing to provide that. THE FRENCH BANKING SECTOR FEARS A HOLLANDE VICTORY. Markets are particularly concerned by the prospect of a Hollande victory although Sarkozy also proposes to introduce a financial transaction (Tobin) tax which would harm the financial sector. Hollande has pledged to separate banks retail activities from speculative investments, a move which would jeopardise Frances universal banking model. Analysts have estimated that his pledge could reduce French bank earnings by up to 10 per cent. The French banking sector is already under pressure due to capital and liquidity rules imposed by the European Banking Authority. Hollande has also proposed a 15 per cent increase in corporate taxation of banks. Of course, several of Hollandes pledges are likely to represent pre-election posturing with a total break-up of the French banking model unlikely. However, French banks are expected to bear an additional tax burden and reduced earnings irrespective of which candidate wins. THE END OF MERKOZY? A Hollande victory would certainly terminate the special relationship between Sarkozy and Angela Merkel. Although their interaction has been plagued by substantial differences in personality and temperament, Merkel and Sarkozy have been forced to learn how to co-operate. Despite differences of opinion the basic understanding between Sarkozy and Merkel that the euro zone needs to put its public finances in order has never been in doubt. Hollande opposes German pressure for additional austerity measures. He also wants the ECB to act as euro

Economic Insights

zone lender of last resort and to change the central banks mandate to also include stimulating economic growth as well as maintaining price stability. With Hollandes attitude to euro zone austerity anathema in Berlin his possible victory risks upsetting the current constructive relationship between France and Germany. THE RUNNERS-UPS. In addition to Sarkozy and Hollande there are several other candidates. While having little chance of progressing to the second round they continue to attract sufficient support to affect the wider campaign. The three most important candidates after Sarkozy and Hollande are described below in order of their average percentage of votes reported in the latest three polls. Jean-Luc Mlenchon [16 per cent]. Left Front (Left Party and French Communist Party) candidate. He appears to be forcing Hollande to adopt an apparently more radical socialist position to avoid losing voters on the left. Most of Mlenchons support is expected to switch to Hollande in the second round. Marine le Pen [15 per cent]. Leader of the right-wing National Front party. She enjoys strong support among young voters. Le Pen has forced Sarkozy to address concerns of far-right voters by threatening to leave the Schengen passport-free zone, and has attacked the perceived influence of Islam on French secular society. Most of her supporters are likely to rally behind Sarkozy in the second round. Francois Bayrou [10 per cent]. Leader of the Centrist party. He has outlined a tough programme to reduce French debt. Bayrou attracts voters who regard Sarkozy as too right wing and others who think Hollande is too much of an old-style Socialist. Andreas Johnson SEB Economic Research + 46 73 523 77 25 andreas.johnson@seb.se

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