The Fall of the Government in France Increases the Risk of a Debt Crisis

Less than a year has passed since the fall of the government of former chief European Brexit negotiator Michel Barnier, and France has been hit by a new political upheaval that is also affecting the economy. As expected, Prime Minister François Bayrou‘s government did not survive the confidence vote in the local parliament on Monday. His minority government lasted since December last year, and it was brought down by the same issue that plagued Barnier’s government, which lasted even shorter, only three months. This is about budget cuts, which are becoming increasingly necessary in the context of the state of French public finances.

 

The situation is such that it increasingly smells of a debt crisis. Given the size of the French economy within the EU, the situation is anything but trivial. Public debt has reached 114 percent of the economy’s value, and the budget deficit is 5.8 percent of GDP. Barnier’s government intended to cut the budget deficit by 60 billion euros; Bayrou was somewhat less ambitious, intending to reduce it by 44 billion euros. Instead of nearly six percent deficit, these austerity measures would result in a deficit of 4.6 percent next year. However, both proposals raised the hackles of both the left and the right.

In addition to austerity measures, increased taxation, and freezing public spending, the opposition reacted negatively to the government’s proposal to abolish one holiday and day off, which would supposedly also bring some savings. Thus, Easter Monday was to be removed from the holiday calendar, which according to claims from the now former government ‘no longer has any religious significance’, as well as May 8, European Victory Day, which commemorates the surrender of Nazi Germany and the end of World War II.

 

The left option particularly emphasized the decline in the standard of public services that would follow these austerity measures, despite the fact that these services are already at an increasingly lower level. For example, there is a shortage of doctors and nurses in public health, there are fewer and fewer railway lines in rural areas, public universities are struggling with an increasing lack of funds, outdated infrastructure, and a decline in research investment. Although these problems are not unique to France, they occur in a country that spends significantly above the European average. Public spending there accounts for more than 57 percent of GDP, thanks to the fact that 51 percent of the economy’s value, or more than one trillion euros, flows into the treasury from taxes.

 

The right, led by the notorious Marine Le Pen, pointed the finger at immigrants and asylum seekers for the budgetary problems. Interestingly, neither option addressed the single largest budget item – 211 billion euros that the government in Paris spends annually on subsidies to companies to encourage them to create new jobs. A large part of that money could be saved if the (overly) rigid French labor legislation, in which dismissals are procedurally difficult and expensive, were amended, as companies are not very interested in hiring too much. However, touching labor legislation in France means touching a hornet’s nest.

With the fall of Bayrou’s government, President Emmanuel Macron has lost his fourth prime minister in less than two years. Nevertheless, the new political upheaval did not significantly affect the increase in borrowing costs: the yield on the ten-year French bond at 3.4 percent was slightly lower than last Friday, and the difference compared to the German Bund remained above 75 basis points. However, this does not mean that France will be able to borrow favorably in the near future: on Friday, September 12, Fitch will announce its assessment of the French credit rating, which is currently at AA–, but with negative outlooks. Therefore, a potential downgrade would not be a surprise. Local financiers are also thinking in that direction.

 

Former Governor of the French Bank Jean-Claude Trichet stated earlier this week that France ‘is facing a combination of a challenging fiscal balance situation and a very difficult political situation’. Analysts for Europe at the Japanese bank Nomura believe that the current fiscal situation in France is worse than that in Italy, which, along with Greece, is considered the financially weakest member of the eurozone.

 

Although Italy’s public debt is significantly higher, at 134 percent of GDP, it has a significantly smaller budget deficit, at 3.4 percent. France and Italy are in the European excessive deficit procedure, which requires that public debt be below 60 percent of GDP, and the budget deficit no more than three percent. While Italy could rein in its deficit in the next year, there are currently no indications that France will succeed in doing so in the next few years, according to Nomura.

The fall of the government means that parliament will most likely not approve the budget for 2026 this year, and the budget for this year will remain frozen at nominal amounts. This, in turn, means that the budget deficit will be somewhat higher than the forecasts of the European Commission, according to Nomura’s analysts, who see a serious problem in the sustainability of French debt. Moreover, there are no solutions on the horizon that would offer the financial market a reason for optimism.

 

The consulting firm Eurasia Group believes that President Macron will not opt for early elections. Therefore, he will most likely appoint another prime minister from the centrist option, with possible candidates including Defense Minister Sébastien Lecornu, Justice Minister Gérald Darmanin, and Finance Minister Éric Lombard. In other words, Macron will give parliament, sharply divided between the left and the right, another target with a short lifespan.