With Macron’s centrist coalition losing public support, the new government that will be formed in parliamentary elections starting on June 30 will likely be formed by both the far-left and the far-right. Both the left-leaning New Popular Front and Marine Le Pen’s far-right Rally National support a host of expensive government programs despite a huge budget deficit equivalent to 5.5 percent of GDP.
“The problem is, given the next government’s plans, there’s no clear path to reducing this deficit. As long as we’re in crisis mode, it makes sense to keep spending, but at some point you have to stop spending,” said Davide Oneglia, director of European and global macro at TS Lombard in London.
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The European Union’s executive body on Wednesday accused France and six other countries of running excessive budget deficits in violation of EU fiscal rules, setting off a formal process to force the spendthrift nations to negotiate with Brussels a plan to return to sound budgeting.
France’s political and financial precarity evokes unpleasant echoes of the European debt crisis that derailed the global economy from 2009 to 2012 and came close to forcing debt-ridden countries such as Greece out of the euro zone.
Since the 2008 financial crisis, France has been able to borrow from investors at roughly the same interest rates as Germany, which has a much smaller debt and deficit burden. But that’s now changing.
“The election has caused a reassessment of risk perceptions in the French market, and I’m not sure that that reassessment was appropriate,” said Neil Shearing, chief economist at Capital Economics in London. “There is a risk that already bad financial conditions could deteriorate significantly further, but I don’t think the wheels will come off.”
France’s budget deficit, the second-largest in the EU after Italy, has ballooned under President Macron’s heavy spending spree, including subsidizing energy prices, to ward off the pandemic and insulate voters from inflation.
France’s budget deficit, at 5.5% of GDP, is smaller than the U.S. deficit, which is expected to reach 6.2% in 2023, according to the Congressional Budget Office. But unlike the U.S., France does not control its own currency, making it more vulnerable to bond market pressures.
Macron has pledged to bring the budget deficit down to a level in line with the EU’s annual 3% target by 2027, when presidential elections are due to take place.
But last month, Standard & Poor’s downgraded the French government’s credit rating from AA to AA-, citing the risk that a widening budget deficit could lead to increased public debt.
Some analysts worry that France’s new government could rebel against the EU and widen the budget deficit, putting new strain on European politics and finances. Three opinion polls released on Thursday showed the Rally National party winning the most votes, followed by the New Popular Front. Macron’s centrist group trailed in each poll.
The National Rally, which nearly doubled Macron’s party’s vote share in the European elections, backs measures that would immediately add more than 12 billion euros to the 154 billion euro budget deficit, according to the Institut Montaigne, a nonprofit think tank in Paris. The right also supports pension reforms that would increase costs by more than 27 billion euros by 2027.
According to the institute, Le Pen ran for president on a platform that would increase the budget deficit by 102 billion euros in 2022.
The new Popular Front, which includes France’s Socialist and Communist parties, has vowed to reverse President Macron’s pension reforms, lower the retirement age from 64 to 60, index salaries to inflation and increase spending on public services.
The left-wing coalition announced on Friday that it would raise taxes to offset a long-term plan to increase public spending by 150 billion euros.
No one knows how many of those campaign promises will hold up in the reality of governing. Some investors have taken solace in the example of Italian Prime Minister Giorgia Meloni, who leads a far-right party with neo-fascist roots but has softened his rhetoric and policies since taking office in 2022.
“All we know is that they have a long list of very expensive wishes,” Onelia said.
French Finance Minister Bruno Le Maire warned that the extreme spending plans could push France into a “debt crisis.” He warned that the budget-busting plans would result in France being placed under an austerity programme overseen by the International Monetary Fund.
IMF officials are already voicing their concerns: The French government will need to make “significant additional efforts” to shore up its finances starting this year, according to IMF economists who visited Paris last month as part of their regular annual review.
The IMF team projects the budget deficit to fall slightly to 4.5% of GDP in 2027, but remain well above the EU limit.
France has the fourth largest bond market in the world and plays a key role in Europe’s decentralized financial environment. French banks and companies use government bonds as collateral for overnight “repo” or repo buyback transactions, which are an important source of routine short-term funding that supports everyday commercial transactions.
Since President Macron bet on early elections, investors have demanded higher yields before buying French government bonds. At the end of last year, the yield, or interest rate, on France’s 10-year government bonds was about 2.4%. It now hovers around 3.2%.
While markets continue to function well, trading is likely to remain volatile until the conclusion of the second parliamentary vote on July 7.
“France is not going to become the new Greece,” said Jacob Kirkegaard, an economist at the Peterson Institute for International Economics.
European Central Bank chief economist Philip Lane told Reuters last week that market movements were not “disorderly” and there was no immediate need for central banks to intervene.
If the new administration were to open the spending taps and upend markets, the Fed would likely be prepared to step in.
The ECB is better prepared to handle a bond-market crisis than it was when Greece disclosed hidden financial problems in 2010. Two years ago, the central bank approved a new mechanism that allows it to buy unlimited amounts of bonds from struggling governments.
The purchases are intended to prevent speculative inflows and drive up government borrowing costs to frightening levels. To be eligible, countries must comply with EU fiscal rules, but in practice the ECB has discretion over how it enforces its requirements.
