Investors eyeball French pension reform plans

Francois Hollande, France's president speaks to the media as he arrives for the European Leaders summit at the European Council headquarters in Brussels,
Bloomberg via Getty Images
Francois Hollande, France's president speaks to the media as he arrives for the European Leaders summit at the European Council headquarters in Brussels,

France is under pressure from Brussels and its euro zone neighbors to deliver budget and pension system reforms, in the nation's latest test to show it can become more competitive, analysts told CNBC.

As France's welfare system is almost entirely paid for by the state, reform is essential if the nation is to balance its public accounts, a move which the European Commission (EC) said in May needed to be "firmly pursued". The EC granted France two extra years to implement "crucial" spending cuts, simplify its tax system, and introduce pension reforms.

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Rising French unemployment has hit the pension pot, and without reform, the funding gap will balloon from its current 14 billion euros ($18.4 billion) to 20 billion euros by 2020, according to French government estimates.

"It is crucial that France's public spending grows significantly less rapidly than potential GDP, as improvements in the structural deficit have so far been mainly revenue-based," the EC said in May. "The pension system will still face large deficits by 2020 and new policy measures are urgently needed to remedy this situation."

However, a dramatic overhaul of the pension system may be impeded by France's powerful trade unions, and strong public opposition to further tax hikes or decreased pensions. The French government is due to meet with union leaders on August 26-27 to discuss final reform plans, before presenting them at a cabinet meeting on September 18.

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"If there is no real reform it will be a very negative shock for the French economy," said Phillipe Waechther, head of economic research at Natixis. He told CNBC that companies in France had already faced 10 years of uncertainty on pension reforms, creating a drag on firms' ability to invest in new technology and industry.

"We need to invest more, and we need companies to invest more, and if we do not have this stable framework, it will disappoint expectations. This reform is very important for the French economy and how foreign investors see us," he said.

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In a morning research note, Barclays said that Finance Minister Pierre Moscovici was "very much aware" of public reluctance for another round of tax hikes, and said his 2014 budget bill would likely reflect this. Nonetheless, the bank forecast the government will opt to increase income tax on pensioners in order to help balance the books.

Fabrice Montagne, senior European economist at Barclays, also forecast that Moscovici would succeed in his move to lengthen the mandatory pension contribution period to 41.5 years. However, he said that concerns remained as to whether the weight of reform would be placed on households, pensioners or companies.

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"If the burden is placed on companies then I think it could make the market nervous, but then again, the market it used to this government spreading the effort on everyone," Montagne said.

"Investors are looking closely at France, but this has been true for at least 3 years. France does have issues over the medium- and long-term, but it is not going to decouple or explode," he added.

By CNBC's Jenny Cosgrave: Follow her on Twitter @jenny_cosgrave