France grapples with economic crisis Ahead of crucial parliamentary elections

In a recent article, The Economist discusses France's economic challenges ahead of parliamentary elections, emphasizing its hefty deficit and escalating debt, which have become focal points of the campaign.

In the 1960s, French politician Valéry Giscard d’Estaing famously coined the term "exorbitant privilege" to describe the advantages enjoyed by the United States as the issuer of the world’s reserve currency, allowing it to comfortably sustain high deficits. Today, France finds itself in stark contrast, facing significant economic challenges as it approaches parliamentary elections scheduled for June 30th and July 7th. The country’s substantial deficit and escalating debt have become central issues in the campaign, exacerbated by an impending move from the European Commission to initiate an excessive-deficit procedure (EDP) on June 19th. This procedure, often likened to the EU’s fiscal disciplinary chamber, compels French policymakers to devise a corrective strategy.

The European Commission's concerns are justified by France's deficit of 5% of GDP, resembling American fiscal practices, which both the country’s central bank and the IMF foresee reducing slowly. Furthermore, France’s debt-to-GDP ratio stands at 111%, echoing Italy’s predicament before the euro crisis of the early 2010s and set to rise further. S&P Global recently downgraded France’s sovereign debt rating from AA to AA- on May 31st, a downgrade that occurred just before President Emmanuel Macron’s decision to call snap elections, potentially ushering in the hard-right National Rally (RN) or the left-wing New Popular Front (NPF) under his ongoing presidency.

Financial markets have reacted with concern, evident in the similar yields on French debt compared to Portugal’s, and a widening spread over German bunds, Europe’s benchmark, now at 0.7%. Since the European Parliament elections on June 9th, France’s stock market has declined by 5%, with firms focused on the domestic market, including major banks like BNP Paribas and Crédit Agricole, experiencing substantial losses. Banks heavily exposed to domestic government bonds, such as La Banque Postale and BPCE, which are not publicly listed, have also been adversely affected.

While political parties in France are not advocating for leaving the euro or the EU, analysts dismiss concerns of an imminent "Liz Truss moment," referencing a surge in British gilt yields after a mini-budget in September 2022. Foreign investors in both French sovereign and corporate bonds remain steadfast, despite warnings from Finance Minister Bruno Le Maire that a victory for either the hard right or left could unsettle markets. France benefits from moderate economic growth projected at 1.3% by the OECD for the next year and manageable debt-servicing costs at 2% of GDP.

However, the crux of the issue lies in the projected widening of France’s deficit to 5.7% this year and 5.9% the next, as forecasted by the French Senate’s finance committee. Although not necessarily crisis-inducing, this trend represents a significant and escalating problem. Minister Le Maire has already enacted approximately €20 billion in spending cuts this year, targeting areas such as energy subsidies and state aid, with further reductions postponed until after the European elections.

The RN, currently polling at over 30% of voters, and the left bloc, close to 30%, lead ahead of President Macron’s centrist alliance. Both factions propose policies that could exacerbate deficits: the right advocates for cuts in electricity and petrol levies and tax exemptions for employers who raise salaries, while the left supports minimum wage increases and reductions in energy and food prices. Both also aim to repeal Macron’s pension reforms, though the RN has moderated its initial stance.

Potential clashes with the European Commission and financial markets loom large, although a victorious RN government may be tempered by the need to court center-right voters ahead of the critical 2027 presidential election. Moreover, any majority government will inherit a precarious fiscal situation requiring stringent spending cuts that could dampen economic growth and prove unpopular with voters. Nevertheless, the outlook is not entirely bleak, as winning elections in France is always an accomplishment, though short-lived celebrations may give way swiftly to the realities of economic governance and policy-making challenges.