Are France's debt issues upon the brink of escalation?
France is grappling with its skyrocketing debt, which is causing unease among financial market investors. The new government's ability to manage the debt has become questionable, leading to higher borrowing costs for France.
The anxiety is reflected in the rising risk premium demanded by investors for French government bonds, in comparison to the German Bunds. Since the surprise early elections in June, where populist parties scored victories, the differential between French and German bond yields has nearly doubled. Currently, the spread between the ten-year bonds of both countries is 0.79 percentage points.
France's new Prime Minister Michel Barnier acknowledges the debt issue, calling it a "serious situation", and advocates for a "national effort". However, the government's hands are tied due to the power dynamics in Parliament, either at the mercy of the right-wing populist Rassemblement National (RN) or the left-wing populist-dominated Nouvelle Union Populaire Ecologique et Sociale (NUPES). This makes it arduous to implement rigorous austerity measures.
France's debt burden stands at 110 percent of its Gross Domestic Product (GDP). Last year, the budget deficit ballooned to 5.5 percent of GDP, well surpassing the EU's permitted three percent. Even the total debt exceeded the EU's limit of 60 percent of economic output.
Deficit procedure initiated
During the COVID-19 pandemic, the EU granted countries flexibility in adhering to their debt rules to provide economic aid. Following a delayed negotiation period, the reform of the "Stability and Growth Pact" was implemented in late April. It requires countries with a debt level above 90 percent to reduce their debt ratio by one percentage point annually.
Given the high debt, the EU Commission initiated a deficit procedure against France. The French government was mandated to submit a plan to Brussels detailing measures to bring the budget deficit below the approved threshold.
The original deadline in September was pushed back by the Commission to mid-October due to the formation of the French government. Yet, the government has reportedly requested an additional extension until October 31st. The EU Commission anticipates that France will need to save 15 billion euros annually for the next seven years, alongside painful reforms.
Barnier aims to present a budget by early October, but passing it through Parliament could prove to be a challenging and uncertain undertaking. Barnier faces the threat of a no-confidence vote due to the absence of support.
The left-wing camp has already announced its intention to submit a motion of no confidence against Barnier's government on October 1st, in principle. The majority coalition failed to secure an absolute majority and needed President Macron's appointment of the conservative Barnier as Prime Minister, whose party managed only five percent in the elections. The survival of the new government depends on the RN supporting the motion of no confidence.
Barnier has mentioned the prospect of tax hikes for the wealthy and large corporations without presuming specifics. He pointed out, "I will not increase taxes for all French people, not for the smallest, not for the working people, not for the middle class. But I cannot exempt the wealthiest from the national efforts to improve the situation."
Barnier's EU and Ministry of Finance counterparts are engaged in discussions to agree on a spending plan regarded as "sufficiently restrictive". However, making such measures palatable to the highly factionalized parliament is a mystery. Even within President Macron's camp, Barnier's plans for tax hikes for the wealthy and corporations encounter resistance.
The high borrowing costs for France are a direct consequence of concerns about its economy and debt, as highlighted by the rising risk premium demanded by investors for French government bonds. The economic instability is further compounded by France's debt burden, which stands at 110 percent of its GDP, surpassing the EU's permitted limit.
Given this serious situation, the EU Commission has initiated a deficit procedure against France, requiring the government to present a plan to bring the budget deficit below the approved threshold.
