The French far-right poses a potential threat to financial stability.
President Emmanuel Macron organized unexpected elections last week as his party lost to the far-right National Rally led by Marine Le Pen in the vote for EU lawmakers.
Markets were shaken by the sudden development, with French stock and government bonds suffering significant drops in value.
If the National Rally wins the most significant influence in parliament and replaces Macron's centrist coalition, it could make it more difficult to reduce France's substantial national debt, equal to 110.6% of the country's GDP as of 2021. A divided government would also grapple with the budget deficit, which reached 5.5% of GDP in 2021.
The financial stability of France is a significant concern, with the potential for a crisis if Le Pen prioritizes her controversial fiscal and protectionist "France first" agenda. This could resemble the financial crisis experienced in the UK when former Prime Minister Liz Truss disclosed her tax-cutting plans in September 2022, causing sharp declines in the pound and UK government bonds.
So far, the economic impact on France is uncertain, as finance minister Bruno Le Maire considers it a "serious risk" but not a definitive forecast. France faces competitive interest rates compared to Portugal, one of the nations that sought aid during the European debt crisis. "It's about the programs and proposals that are out there, whether we can, yes or no, finance the national debt," he stated.
Despite the risk, credit ratings agencies continue to monitor France, one of the most indebted countries in the EU. In May, S&P downgraded France's long-term credit score to AA-, citing the worsening fiscal position. The agency expects France's budget deficit to decrease to 3.5% of GDP by 2027, considerably higher than the current government's target.
Financial markets have shown nervousness about the potential political instability, leading to higher interest rates on France's 10-year government bonds compared to Portugal's and relative to more secure German equivalents. The difference in premiums reached its highest level since 2017, and the gap was growing further.
Investors have also experienced increased volatility in stock markets. On May 5, France's benchmark CAC 40 index plummeted more than its German or pan-European counterparts. Additionally, the euro's value decreased this week, indicating market instability.
A BFMTV and La Tribune Dimanche poll conducted by Elabe, an opinion researcher, suggests that Macron's centrist party may only place third in the first round of elections on June 30. The National Rally has proposed raising public spending and lowering VAT on electricity and fuel.
In a webinar on May 5, Frank Gill, senior specialist in European sovereign ratings at S&P Global Ratings, acknowledged that such policies would "further drag on public finances" and "would be a consideration for the sovereign rating." Additionally, the ratings agency Moody's deemed the snap elections a "credit negative," increasing the risks to fiscal consolidation in France.
According to a Berenberg note, the European Central Bank "would have the tools to prevent any genuine crisis" in the French government bond market. However, they noted that the ECB may only use its instruments or encourage their use when a country returns to "more financially sound policies."
Contributions to this story from Joseph Ataman in Paris and Mark Thompson in London.
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Given the current political uncertainty in France, some investors might consider diversifying their business portfolio by investing in more stable European markets or securities. If Le Pen's National Rally gains significant influence in parliament, implementing their fiscal and protectionist policies could increase France's borrowing costs and make it more challenging to manage its substantial national debt, potentially impacting investments negatively.
