Q&A: Are concerns about the French economy overblown?

Fake euro notes placed by strikers on the gates outside the Paris Stock Exchange in November 2011 France has strong assets, but can it avoid falling into the same problems as Greece and Ireland?

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France was stripped of a gold-plated credit rating last week, days after a controversial Economist cover - showing a bundle of baguettes tied together with a lighted fuse to resemble a time bomb - sparked fury among officials.

France is in the spotlight amid fears it could become the next focus of the crisis in the eurozone following Greece, Portugal and Ireland.

Yet France is unlike her southern neighbours.

It is the second largest economy in the eurozone and has Fortune 500 companies ranging from cosmetics leader L'Oreal, energy group Total and luxury giant PPR, which boasts UK brands Stella McCartney and Alexander McQueen.

What is so worrying about France?

Who is worried?

Investors and policymakers in Europe have expressed concerns that the financial markets could turn against France.

Moody's decision to downgrade France's sovereign debt means it believes the risk of the country defaulting on its debts has increased.

If investors in French government bonds lose confidence in Paris's ability to repay, then they will demand a higher premium on their loans. That would make it more expensive for the country to borrow on international markets.

Countries such as Greece, Ireland and Portugal have been effectively shut out of borrowing long term on international financial markets, which forced them to seek help from European partners and the International Monetary Fund.

French banks are exposed to the troubled eurozone economies, and its rigid labour market is also harming competitiveness.

The IMF has warned that France's economic outlook would deteriorate if it failed make deep spending cuts like Greece, Italy and Portugal.

The international lender predicts economic growth of a mere 0.4% in 2013, up from 0.1% this year.

Meanwhile, French business leaders "are in a state of quasi-panic," according to Laurence Parisot, the head of the employers' association Medef.

"The pace of bankruptcies has accelerated over the summer. We are seeing a general loss of confidence by investors. Large foreign investors are shunning France altogether. It's becoming really dramatic."

What's the French government's position?

"Austerity need not be Europe's fate," the socialist president Francois Hollande has said.

For all the talk of a one-size-fits-all economic policy across the eurozone, France has bucked the trend, abandoning austerity and protecting its social model.

It opposes slash-and-burn policies, suggesting that deep spending cuts have proven to be harmful to economies. Greek public debt, for example, is expected to grow, not shrink.

Finance Minister Pierre Moscovici said last week: "France is not the sick man of Europe. France remains the world's fifth largest economic power that has all its resources but which needs to recover its competitiveness.

"No, we are not implementing the same reforms as Italy and Spain because we are not Italy or Spain. We don't have the same weaknesses. So we will implement reforms a la Francaise. They will be more ambitious than any [French government] before us."

How does France compare with other major economies?

France's public debt recently topped 90% of the value of everything produced in the economy in a year, well above the eurozone average of 60%.

However, its debt level is not an enormous amount greater than the UK or Germany.

"These numbers are not unusual in the context of eurozone economies in general," says Bill Witherell, chief economist at Cumberland Advisors.

"What distinguishes France is the lack of political will to address them and, as a consequence, a projected debt to GDP ratio which would place it firmly" among its crisis-hit neighbours, he added.

President Hollande has promised to reduce France's government deficit to below 3% of economic output by next year from the current 4.5%.

The president has generally favoured tax increases over spending cuts to plug the gap between government revenue and expenditure.

The tax increases will largely hit companies and the wealthy - at some of the highest rates in Europe, as well as a planned increase in the VAT rate from 19.6% to 20% and another three percentage point increase in tax on restaurants.

Some top earners and businesses have threatened to leave the country as a result of the planned tax rises.

France has also avoided taking major steps to improve competitiveness when average wages in France are among the highest in Europe (and 20% higher than in Germany since the launch of the euro).

Louis Gallois, a well-respected industrialist, urged the government to take "shock therapy" that would slash labour costs by 30bn euros (£24.2bn; $38.8bn).

His calls received only a lukewarm response before the government conceded to 20bn euros worth of tax credits for companies over two years, equivalent to a 6 percent cut in labour costs.

Higher labour costs make it difficult for companies to compete and create value, which is crucial to job creation.

France has lost 700,000 industrial jobs over the past decade, and the unemployment rate is now at 13-year highs of about 10%.

That compares with 5.4% in Germany, its main trading partner and competitor. Nearly a quarter of French youth are unemployed.

So where is France headed?

President Hollande's predecessor Nicolas Sarkozy warned in his presidential campaign that France would become the next Greece and face an economic meltdown if he wasn't re-elected.

So far that hasn't happened.

France has avoided slipping into negative growth and there is still appetite for French government bonds, meaning investors do not currently see France as a credit risk, says Thomas Costerg, economist at Standard Chartered.

But with exports and growth expected to remain anaemic, "the French economy is at risk of sliding into recession, which could push up its debt further", he says.

It is unlikely that financial markets will bet against France tomorrow. But the government will need to do more to retain investor confidence in the country in the long run. That could involve Mr Hollande breaking his promises and potentially losing the public's vote of confidence - a tough decision to make.

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