Government crisis

France struggles with extreme new debt

Will Macron's announcements be enough?

(Bild: APA/AFP/Ludovic MARIN)

Following the fall of the government in Paris, French President Emmanuel Macron is trying to dispel concerns about the country's paralysis and a financial crisis.

A new prime minister will be appointed quickly, a bridging solution will be agreed by mid-December in view of the rejected austerity budget and then a new budget will be adopted at the beginning of 2025, Macron emphasized. Will his announcement be enough to avert a tangible crisis in France with repercussions for the EU?

How critical is France's financial situation?
The dispute over the 2025 budget revolves around the question of how to bring the sharp rise in new debt under control. Resigned Prime Minister Michel Barnier had warned that the budget deficit could rise to over seven percent next year. This would be more than twice as much as stipulated in the Maastricht Treaty. The national debt ratio was around 110 percent at the end of 2023. This is the third-highest figure after Greece and Italy. Overall, France's debt mountain is around 3.2 trillion euros and is the highest in Europe in absolute terms.

What happens next?
Barnier had proposed a mix of lower spending and higher revenue with a volume of 60 billion euros. This will not happen for the time being. But even a future prime minister will not be able to avoid budget consolidation. There is a threat of deficit proceedings by the EU Commission. Adopting a budget is likely to be difficult. This is because the centrist parties do not have a majority.

Tourists in front of Notre-Dame Cathedral

(Bild: APA/AFP/Dimitar DILKOFF)

What significance does the crisis in France have for the EU and Germany?France is the second largest economy in the eurozone after Germany. The government crisis in France has left both countries without a government that is fully capable of acting. This restricts the EU's ability to act. The inauguration of Donald Trump in the US also threatens a trade conflict and a U-turn in Ukraine policy.

How do the financial markets view the government's resignation?
Barnier had warned of severe turbulence before the vote of no confidence if the budget plans and his government were to fail. However, reactions on the financial markets were cautious. Following the successful vote of no confidence in the National Assembly, risk premiums on French government bonds actually fell. Prior to this, however, yields on French government bonds had risen and at times reached the level of Greece for the first time since the eurozone came into existence.

"Market participants are frowning on France, but are not turning away," commented Ulrich Kater, Chief Economist at Dekabank. "This is based on the expectation that the eurozone's second-largest economy will present a perspective for consolidating its budget despite all internal political differences." This is particularly true if the financial markets send out clear stress signals.

Market participants are frowning at France, but are not turning away.

Chefvolkswirt Ulrich Kater

Are comparisons with the crisis in Greece 2010-2012 justified?
Comparisons with Greece have recently become more frequent. However, they are flawed. France has a strong economy and functioning institutions. The Organization for Economic Cooperation and Development (OECD) expects economic growth of 1.1% in France this year. Only stagnation is forecast for Germany. The interest rates that France has to pay on the capital markets are still significantly lower than in Greece at the time of the euro crisis.

"We do not expect the French mess to trigger anything similar to the euro confidence crisis of 2010-2012," commented the chief economist at Berenberg Bank, Holger Schmieding. He does not expect discussions about leaving the eurozone. "Europe has learned the lesson of Brexit." Even Marine Le Pen no longer wants to leave the euro or the EU.

What dangers are still looming?
The rating agencies could downgrade France's credit rating further. This could make borrowing even more expensive. "This event is bad for the credit rating," said the rating agency Moody's, referring to the vote out of office of the government in Paris. In addition, there is no prospect of stable political conditions in France in the medium term. The political uncertainty could therefore also have a negative impact on companies' investments. Finally, it is unclear what future tax legislation will look like.

How could the ECB react to a possible worsening of the crisis?
In contrast to the sovereign debt crisis of 2011 and 2012, the European Central Bank (ECB) has effective instruments at its disposal. With the TPI bond purchase program launched during the euro crisis, it could buy unlimited amounts of bonds from individual eurozone countries in the event of a crisis. "The mere fact that the ECB can intervene should prevent a spillover to other countries and also prevent French yield premiums from reaching the heights that were reported in 2011," commented Thomas Gitzel, Chief Economist at VP Bank. "Nervousness is likely to remain high for the time being, but no new euro crisis is to be expected - the ECB's protective shields are too powerful for that."