“Low-flation” in France: Price and Growth Stagnation
In a context of slow inflation (“low-flation”) and flat growth, France is in danger of not being able to escape the vicious circle of falling prices. It is possible that France, without going to the extremes of US Great Depression, could experience a lengthy period of price and growth stagnation, such as happened in Japan between 1990 and 2010. If so, what would it mean for the French economy and its companies?
20 years of “low-flation” in Japan, what lessons can we learn?
Japan went through a 20 year period of “low-flation” between 1990 and 2010, with average growth of +1% and inflation at +0.3%. With its economy overheating following its opening up in the 1980s, Japan suffered a first wave of insolvencies at the beginning of the 1990s. Many companies there, with low profitability, high debt levels and overcapacity, suffered when the banks tightened their lending terms as they themselves were being undermined by runaway inflation, followed by deflation. After a brief respite in 1997, when prices again started to rise due to an increase in VAT rates, the period of “low-flation” took over once again until 2010.
There were a number of factors behind this long period of price stagnation. First, the consolidation of the banking system was delayed too long. Second, the “zero rate” policy of the Bank of Japan did not work, with the plentiful money supply failing to have a positive impact on the real economy. Finally, as real growth in the Japanese economy was below its potential growth rate during this period, unused production capacity drove prices down.
While the risk of severe deflation is unlikely, the threat of a prolonged period of “Japanese style low-flation” is real
France will likely avoid real deflation, for reasons that include wage resilience, the ready availability of cheap liquidity, and an innovative central bank that is active in guaranteeing market stability. These factors were desperately missing in the 1930s and should enable the Eurozone to avoid the deflationary trap.
However, the probability of going through an extended period of “low-flation” and weak growth seems more likely. Both growth and inflation have in fact been following a downwards path since 2011. Based on the forecasts from Coface, GDP growth is unlikely to exceed 0.4% in 2014 and 0.8% in 2015, levels that are significantly below the level of 2011 (2.1%). Similarly, consumer prices have increased by just 0.5% so far in 2014 and inflation will run at an average of 0.7% in 2015, compared with 2.3% in 2011.
What are the risks and opportunities for French companies?
As in Japan in the 1990s, “low-flation” in France is an indirect consequence of the crisis.
This simultaneous decline in growth and inflation is mainly the result of weak demand, a normal occurrence in periods following a crisis. The existence of overcapacity means that many industrial sectors are especially vulnerable to any slowing in inflation. In these situations companies tend to prefer building their cash balances rather than investing, which is counterproductive for medium-term growth prospects.
“Low-flation” does have certain benefits for the French economy. First of all, it boosts household purchasing power and therefore consumption, which is still the key driving force for economic growth. Companies benefit from more favorable financing terms due to low interest rates, and from lower production costs.