With Macron’s centrist coalition losing public support, the extremes of the far left and far right are poised to shape whatever new government emerges from the parliamentary vote that begins on June 30. Both the left-wing New Popular Front and Marine Le Pen’s far-right National Rally have a long list of expensive government programs despite a growing budget deficit equal to 5.5 percent of output.
“The problem is that there is no clear path – given the plans of the next government – to reduce this deficit. As long as we remained in a state of crisis, it made sense to continue spending. But at some point, you have to stop,” said Davide Oneglia, director of European and global macro at TS Lombard in London.
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On Wednesday, the European Union’s executive arm punished France and six other countries for running excessive budget deficits, in violation of the bloc’s fiscal rules. The declaration begins a formal process that will force spending countries to negotiate a plan with Brussels to return to sound budgeting.
France’s plunge into political and financial uncertainty carries uncomfortable echoes of the European debt crisis that rocked the global economy from 2009 to 2012 and nearly drove debt-ridden countries like Greece out of the eurozone.
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 lower debt and deficit burden. This is now changing.
“The market’s perception of risk in France has been reassessed due to the elections. Whether this repricing has been adequate or not, I’m not sure,” said Neil Shearing, chief economist for Capital Economics in London. “There is a risk that the financial situation will worsen significantly from an already bad position. But I don’t think you’re going to end up with the wheels falling off.”
The French deficit – the EU’s second largest after Italy’s – soared as Macron spent heavily to stave off the pandemic and protect voters from inflation, including subsidizing energy prices.
France’s deficit – at 5.5. manufacturing percentage — is less 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 currency and is thus more vulnerable to bond market pressures.
Macron has promised to bring the deficit in line with the EU’s 3 percent annual target by 2027, when presidential elections are expected to take place.
But last month, Standard & Poor’s downgraded the French government’s credit rating to AA- from AA, citing the likelihood that wider budget deficits would increase public debt.
Some analysts worry that a new French government will widen the budget deficit further in defiance of Brussels, putting new strains on European politics and finances. Three polls published on Thursday showed the National Rally winning the majority of the vote, followed by the New Popular Front. Macron’s centrist group was ranked in each of the polls.
National Rally, which roughly doubled Macron’s party’s share of the vote in European elections, backs measures that would immediately add more than 12 billion euros to the 154 billion euro deficit, according to the Institut Montaigne, a non-profit think tank in Paris. The right-wing also backs pension changes that would add more than €27bn to costs by 2027.
In 2022, Le Pen ran for president on a platform that would add 102 billion euros to the deficit, the institute said.
The New Popular Front, which includes France’s Socialist and Communist parties, vows to reverse Macron’s pension changes by lowering the retirement age to 60 from 64; relate wages to inflation; and increased spending on public services.
On Friday, the left-wing coalition said it would raise taxes to offset a planned increase in public spending over time of 150 billion euros.
No one is sure how many of these campaign promises would survive the reality of governance. Some investors take comfort in the example of Italian Prime Minister Giorgia Meloni. Although he leads a far-right party with neo-fascist roots, Meloni has moderated his rhetoric and policies since taking office in 2022.
“The only thing we know is that they have long wish lists that are very expensive,” Oneglia said.
French Finance Minister Bruno Le Maire has warned that France could suffer a “debt crisis” if the spending plans of either political extreme were implemented. The budget-busting programs will result in the country being placed under an austerity program overseen by the International Monetary Fund, he warned.
IMF officials are already raising concerns. The French government will need “significant additional efforts” starting this year to shore up its public finances, according to fund economists who visited Paris last month as part of a routine annual review.
The IMF team projects that the budget deficit will fall only modestly to 4.5 percent of GDP in 2027, leaving it well above EU limits.
France has the fourth largest bond market in the world, giving it a vital role in Europe’s fragmented financial landscape. French banks and businesses use government bonds as collateral in “repo” or overnight repurchase transactions, a key source of routine short-term funding that supports day-to-day trading.
Since Macron played in the snap election, investors have sought a higher return before buying French bonds. The yield, or interest rate, on the benchmark 10-year French government security at the end of last year was around 2.4 percent. Now it stands close to 3.2 percent.
Although markets continue to function smoothly, trading is likely to remain volatile until the conclusion of the second round of parliamentary voting on July 7.
“This does not mean that France is the new Greece,” said Jacob Kirkegaard, an economist at the Peterson Institute for International Economics.
The European Central Bank’s chief economist, Philip Lane, told Reuters last week that there was no immediate need for central bank intervention as market movements were not “erratic”.
If a new government upsets the markets by opening up the spending branch, the monetary authorities would probably be prepared to intervene.
The ECB is better prepared today to respond to a bond market crisis than when Greece revealed its hidden financial problems in 2010. Two years ago, the central bank approved a new mechanism that would allow it to buy an unlimited amount of bonds from a struggling government.
Such purchases would be designed to prevent a speculative run that could drive government borrowing costs to punitive levels. To be eligible, a country is supposed to comply with EU fiscal rules. But in practice, the ECB has discretion on how to implement its requirements.