Drowning in debt: Investors dump France ahead of elections

Macron has spent a fortune, bond yields are going up, stocks are falling, Brussels is demanding reform, the IMF is preparing an emergency package, and populists are at the gate... Sacré bleu!

Macron is accused of drowning France in debt, with new loans exceeding €1tn in his seven years in office, despite poverty levels having risen.
Macron is accused of drowning France in debt, with new loans exceeding €1tn in his seven years in office, despite poverty levels having risen.

Drowning in debt: Investors dump France ahead of elections

France’s snap elections today (June 30) will be a crucial test of the nation’s politics, pitting the far right against the far left in a contest that will resonate throughout Europe. However, while voters ponder the candidates, the European Commission is issuing warnings about the size of France’s budget deficit. This is of concern, given that France is Europe’s second-largest economy after Germany.

Yet France is not alone. Six other European Union (EU) countries have been put on notice over breaches of the Stability and Growth Pact. This ties the bloc’s economies into shared structural territory in part by setting a 3% limit on budget deficits. The French budget deficit was 5.5% of gross domestic product (GDP) in 2023, well above the target, while its public debt now stands at 112% of GDP.

The big ratings agencies are unimpressed. Last year, Moody’s downgraded French debt, and in early June, Standard & Poor’s did likewise. This is the first time that France’s sovereign ratings have been downgraded in more than a decade. Failure to address this by 2027 (the rules were defined in 2012) could result in penalties, and although this gives three years for corrective actions, the warning is a reminder of just how precarious the French economic position has become.

Issuing debt warnings

Together with Paris's apparent lack of appetite to cut French spending, this is stoking wider fears that heavily indebted nations could trigger a fresh European crisis reminiscent of the problems posed by Greece in the eurozone a decade ago. The European Commission has warned that French debt-to-GDP could approach 140% by 2034 on current trends. Such a French economic shudder would impact across the eurozone, the Mediterranean, and even North Africa (a large North African diaspora makes up 12% of France’s population).

Brussels has told Paris and others to submit a detailed letter of intent by 20 September outlining reform plans. In France, the heated political climate and uncertainty generated by the upcoming election have made this almost impossible. Whoever is part of the new government will have to show how they intend to cut the deficit to 4% over four years, which is in line with a pledge made to the International Monetary Fund (IMF) last May.

The French budget deficit was 5.5% of the GDP in 2023, well above the target. It now stands at 112% of GDP. 

To win elections, few politicians promise spending cuts or tax rises, yet the populism being seen could easily exacerbate the financial situation. Parties like the National Rally and the New Popular Front dislike Europe's laws and regulations. Instead, they advocate for more national sovereignty, especially on the far right. That could run the risk of social fragmentation, economic collapse, and deepening disputes with European and Maghreb neighbours, as well as with allies and friendly alliances, such as the United States, NATO, and the G20.

Reform and prestige

The IMF issued its most recent report on the French economy after an annual review in May before President Emmanuel Macron called the snap election. It said the French economy had "surpassed imbalance and entered a phase of uncertainty due to several factors, including geopolitical risks, social unrest, and internal political fragmentation, which could delay financial balances and impede reforms, thereby affecting investor confidence and economic prospects".

The IMF's call for France to reduce its debt burden and modernise its economy is in line with the demands of other big financial institutions. Despite their differences in other areas, all French politicians seem to agree that France is underperforming. Although France announced €10bn in budget cuts in February, with a further €10bn planned, critics accuse Macron of drowning the country in debt, with new loans exceeding €1tn in his seven years in office. They also claim that poverty levels have also risen.

The IMF thinks Paris could reduce its budget deficit to 4.5% by 2027 if reforms continue and unnecessary spending is cut, assuming no big change in political direction. In this scenario, debt increases by 1.5% of the GDP annually, but this scenario is less pessimistic than alternatives. If Macron loses to the far right or far left, they could start spending more on social programmes, cut taxes, or end the current economic reforms.

The IMF is preparing for this with a strict structural adjustment programme for France similar to those seen in Greece, Portugal, and states in Africa and Latin America. The indignity of a bailout would greatly wound French pride. Le Point, a newspaper deemed close to Macron, asked if the country was about to lose its world power status.

Political possibilities

The French parliamentary elections, which run for a week from 30 June, are expected to be won by the far-right National Rally (NR) led by Marine Le Pen. The NR won 32% of the vote in the last European elections (up to 42% in areas with big Muslim populations). It could win an absolute majority this time, making Jordan Bardella the youngest ever French prime minister, or New Popular Front (a leftist coalition led by France Unbowed) could win the most seats, making Jean-Luc Mélenchon prime minister.

Far-right National Rally party president Jordan Bardella, right, leaves with far-right leader Marine Le Pen after a press conference, Monday, June 24, 2024 in Paris.

Alternatively, there could be a hung parliament, in which no group secures an overall majority of at least 289 seats. This risks political paralysis and constitutional crisis, limiting the country's ability to function and deepening social divisions.

Jean-Philippe Tanguy of NR has threatened to deport illegal immigrants and stop remittances to those countries that refuse to take deportees, for instance. He also wants to abolish birthright citizenship, reduce social aid, revise immigration and asylum laws, and close extremist mosques.

To attract young French voters, NR wants to exempt those under 30 from tax, revisit the retirement law for those who began working before the age of 20, and lower taxes on electricity and fuel. It also wants to suspend some EU laws, audit public finances and contracts, and offer incentives to French companies. An additional €100bn financial burden is expected if there is a Bardella or Mélenchon government.

Worryingly, hostility towards foreigners and minorities in France could grow, depending on who wins. The Washington Post predicts post-election instability—with economic and social difficulties and even street clashes.

Into uncharted territory

Olivier Blanchard, a professor at the Massachusetts Institute of Technology (MIT) and a former IMF analyst, said the implementation of programmes presented to voters "would lead to a frightening budget deficit… it would explode the debt, drain tax resources, increase repayment and borrowing costs, and hinder growth".

Frederick FLORIN / AFP
Farmers drive their tractors during a protest called by local branches of major farmer unions FNSEA and Jeunes Agriculteurs, blocking the A35 highway with tractors near Strasbourg, eastern France, on January 30, 2024.

French public finance think-tank Fipeco said the cost of servicing public dept would rise significantly to €292bn within four years, an increase of €56.4bn from the current level.

"The French economy is under the watch of financial markets," said Fipeco president François Ecalle. "They don't hide the legitimate concerns among investors, who might react strongly and suddenly to any political event."

The 2024 budget deficit is estimated at around €144bn, while the general budget needs at least €300bn in revenues this year. This will mean borrowing on the global markets. The French Treasury regularly issues Eurobond debt over the medium and long term. France is now the EU's biggest government bond market, with around €2.46tn now outstanding. The yield on these bonds rose by 0.25% in a week, reflecting financial market concern about debt.

The prospect of a politically extreme party has spooked investors, the Paris stock market operator Euronext said this week. Alternative markets—like London and Frankfurt—may now look more attractive. France's main share index, the CAC40, is back down to levels last seen in February, losing 160 points in ten days. Since Macron's surprise election announcement, financial newspaper Les Échos said €200bn had been wiped off French stocks.  

Voters will be concerned that food prices are up 20%, while fuel and electricity bills are up by 42%, and ten million people are now below the poverty line in France. These statistics suggest that Paris could be set for big changes. The markets have already priced these in.

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