When the going got tough, European finance ministers would sigh and say at least they weren’t Greek. Some people today would have a hard time making such comments. On December 2nd, Greek government bond yields fell below French government bond yields, indicating that investors believe it is safer to lend to Greece than to France. French government bonds currently yield 0.8 percentage points above the eurozone benchmark, German bonds, the widest difference since the euro was on the verge of collapsing in 2012. On December 4, the French government collapsed in quick succession over spending.
premium Will Europe’s finance ministers soon sigh and say at least they are not French? The EU’s second-largest economy is facing serious problems. The first is the government’s budget deficit. At more than 6% of gross domestic product, this year’s figure will ultimately be much higher than government expectations or independent forecasters expected. To make matters worse, the IMF expects the budget deficit to remain at this level (well above the 3% maximum mandated by the European Commission) until the end of the decade.
France’s huge deficit has pushed France’s debt levels even higher, with debt levels expected to reach 115% of GDP next year, about 17 percentage points higher than in 2018. According to the IMF, by 2029, the share of GDP will reach 124%. Therefore, spending on interest payments is expected to increase from 1.9% to 2.9% of GDP. And it is based on expectations for healthy economic growth. Goldman Sachs has lowered its growth forecast for next year to just 0.7%. If the bank’s analysts are correct, interest payments will become even more painful and debt will remain high relative to GDP.
France is not the only country spending big. Even countries known for being fiscal hawks, such as Austria, Germany and the Netherlands, have experienced widening budget deficits in recent years (see graph). The situation was set in motion by the coronavirus disease (COVID-19) pandemic and the energy crisis caused by Russia’s invasion of Ukraine. In fact, Sander Trudwar of the Center for European Reform think tank says governments spent more on economic support in 2022 than they did after the 2007-2009 global financial crisis. Then, as memories of the euro crisis faded, politicians spent heavily to increase spending on the green transition and its military, while at the same time reducing burgeoning support for populist parties.
Currently, each country is submitting its fiscal consolidation plan to the European Commission. France’s policy is ambitious, aiming to reduce the deficit by 0.5 percentage points of GDP annually, enough to stabilize debt levels. But at the moment, such a plan seems politically impossible. And the French government is not alone in coming to terms with budget constraints. Germany also recently collapsed over a dispute over spending. Italy will feel the strain in the coming years.
read more:
Jean-François Roban of Banque Natixis expects French spreads over German bonds to fall over next year and rise again ahead of parliamentary elections likely to be held in the summer. This reprieve does not reflect the country’s economic outlook, but rather the fact that France benefits from being in the core of the eurozone, along with Germany. Historically, this position has meant that France has been able to borrow at interest rates similar to Germany while pursuing more expansionary fiscal policy, said Davide Oneglia of consultancy TS Lombard. It now prevents the country’s borrowing costs from actually rising.
Whether the market continues to offer such concessions will depend on how politically unstable France becomes. There is no immediate threat of a financial crisis, banks remain strong, and the European Central Bank (ECB) has made it clear, though not explicitly stated, that it supports member countries’ debts. But unless France shows real commitment to reducing its deficit, it will be difficult for the ECB to step in and buy French bonds. If France’s spreads continue to widen, central bank policymakers will be in a politically awkward position. They may have to prepare for an even more awkward situation, as France is just one of many countries struggling to make ends meet.
For more expert analysis on the biggest stories in economics, finance and markets, sign up for Money Talks, our subscriber-only weekly newsletter.
