As Macron’s centrist coalition loses public support, the far left and far right are poised to shape the new government that will emerge from parliamentary voting beginning June 30. The left-wing New Popular Front and Marine Le Pen’s far-right National Rally support a long list of costly government programs, despite a yawning budget deficit equal to 5.5 percent of output.
“The problem is that there is no obvious path – given the plans of the future government – to reduce this deficit. As long as we remained in crisis mode, it made sense to continue spending. But at some point you have to stop,” said Davide Oneglia, European and global macro director at TS Lombard in London.
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The European Union’s executive reprimanded France and six other countries on Wednesday for running excessive budget deficits, in violation of the bloc’s fiscal rules. The declaration marks the start of a formal process that will require high-spending countries to negotiate a plan with Brussels to return to sound budgeting.
France’s plunge into political and financial uncertainty is uncomfortably reminiscent of the European debt crisis that shook the global economy from 2009 to 2012 and nearly drove debt-ridden countries like Greece out of the euro zone.
Since the 2008 financial crisis, France has been able to borrow from investors at roughly the same interest rate as Germany, a country with a much smaller debt and deficit burden. This is changing.
“The market’s perception of risk in France has been reassessed due to the elections. Whether that price revision was adequate or not, I’m not sure,” said Neil Shearing, chief economist at Capital Economics in London. “There is a risk that the already poor financial situation will deteriorate significantly. But I don’t think the wheels will eventually fall off.
France’s deficit – the second-largest in the EU behind Italy – swelled after Macron spent massively to stave off the pandemic and protect voters from inflation, including by subsidizing energy prices.
France’s deficit — at 5.5. percent of production – is lower than that of the United States, which reached 6.2 percent in 2023, according to the Congressional Budget Office. But unlike the United States, France does not control its own currency and is therefore more vulnerable to bond market pressures.
Macron has promised to bring the deficit back to the level of the 3% annual target set by the EU by 2027, the date of the presidential elections.
But last month, Standard & Poor’s lowered France’s public credit rating from AA- to AA-, citing the likelihood that wider budget deficits would increase public debt.
Some analysts fear that a new French government could widen the budget deficit further, in defiance of Brussels, putting new strains on European politics and finances. Three polls published Thursday show the National Rally winning the largest share of votes, followed by the New Popular Front. Macron’s centrist group is at the bottom of the pack in each of the surveys.
The National Rally, which nearly doubled Macron’s party’s vote share in the European elections, supports measures that would immediately add more than 12 billion euros to the 154 billion euro deficit, according to the Institut Montaigne, a group of non-profit think tank based in Paris. The right-wingers also support changes to pensions which would result in an additional cost of more than 27 billion euros by 2027.
In 2022, Le Pen ran for president with a program that would have added 102 billion euros to the deficit, the institute said.
The New Popular Front, which includes the French Socialist and Communist parties, pledges to reverse Macron’s pension changes by lowering the retirement age from 64 to 60; link wages to inflation; and increase spending on public services.
On Friday, the left-wing coalition announced it would raise taxes to offset a planned increase in public spending of 150 billion euros over time.
No one knows exactly how many of these election promises would survive the government’s reality. Some investors console themselves by relying on the example of Italian Prime Minister Giorgia Meloni. Although she leads a far-right party with neofascist roots, Meloni, since taking office in 2022, has moderated her rhetoric and policies.
“The only thing we know is they have long wish lists that cost a lot of money,” Oneglia said.
French Finance Minister Bruno Le Maire has warned that France could suffer a “debt crisis” if spending plans from both political extremes are adopted. Fiscal austerity programs would result in the country being placed under an austerity program supervised by the International Monetary Fund, he warned.
IMF officials are already expressing their concerns. The French government will need “substantial additional efforts” starting this year to strengthen its public finances, according to the fund’s economists who visited Paris last month as part of a routine annual review.
The IMF team projects that the budget deficit will decline only modestly to 4.5% of GDP in 2027, which would leave it well above EU limits.
France has the world’s fourth-largest bond market, giving it a vital role in Europe’s fragmented financial landscape. French banks and companies use government bonds as collateral in overnight repo or repurchase transactions, a key source of short-term current financing that supports daily commerce.
Since Macron bet on early elections, investors have demanded a higher yield before buying French bonds. The yield, or interest rate, on the French government’s benchmark 10-year security at the end of last year was around 2.4 percent. It now stands at almost 3.2 percent.
Even if markets continue to operate smoothly, trading is likely to remain volatile until the conclusion of the second round of parliamentary votes on July 7.
“This is not to say that France is the new Greece,” said Jacob Kirkegaard, an economist at the Peterson Institute for International Economics.
Philip Lane, chief economist at the European Central Bank, told Reuters last week that central bank intervention was not immediately necessary as market movements were not ” disordered.”
If a new government disrupted markets by opening the spigot to spending, monetary authorities would likely be ready to intervene.
The ECB is better prepared today to respond to a bond market crisis than it was when Greece revealed its hidden financial problems in 2010. Two years ago, the central bank approved a new mechanism that would allow it to purchase an unlimited number of bonds from a government in distress.
Such purchases would be designed to prevent a speculative run that could drive a government’s borrowing costs to punitive levels. To be eligible, a country must respect EU budgetary rules. But in practice, the ECB has discretion over how to implement its own requirements.