France: Political Uncertainty Weighs on Public Finances and Funding Conditions

President Emmanuel Macron’s choice of Michel Barnier, a centre-right politician and the EU’s former Brexit negotiator, as France’s new prime minister leaves open the question of whether he can form a stable government with enough support in a deeply divided parliament to materially reduce the budget deficit and enact major supply-side reforms necessary to bolster the economy’s growth potential. Scope Ratings rates France AA/Negative Outlook.

The yield spread between French 10-year government debt and those of other core euro area countries has widened to around 40bp, up from a five-year average over 2019-23 of about 16bp, since President Macron’s decision to call early legislative elections (Figure 1). This points to a moderate, albeit rising, divergence of France’s funding conditions compared with those of AAA-rated sovereigns.

France’s G7 status, economic resilience, weight in European governance, and robust institutional strength have so far mitigated concerns over the successive budget deficits of French governments. However, the additional degree of political uncertainty since the snap elections in June has combined with a deteriorating fiscal outlook despite the post-pandemic economic recovery.

France’s 2024 budget deficit is likely to be revised up to 5.6% of GDP from 5.1% planned in the Stability Programme. This points to another year of fiscal slippage as the 2023 deficit had already been revised to 5.5% of GDP from the planned 4.9%. France is thus set to record the second widest budget deficit among euro area countries, after Slovakia (5.9% of GDP), and significantly above the 3% Maastricht threshold.

Figure 1. France’s funding costs rising vs core euro countries, convergence with that of the euro-area periphery

Spread, 10-year government bond yield, basis points

Political Uncertainty Drives Further Convergence with Euro Area Periphery

France’s bond spread to euro area peripheral countries began tightening before the early legislative elections this summer. This convergence reflects both France’s challenging credit outlook but also the strengthening credit fundamentals of sovereigns such as Greece, Portugal and Spain, which have significantly reduced their government debt, including via forecasts of achieving primary balances or surpluses (Figure 2). As a result, France’s spread to the periphery has narrowed to -25bp, well below a 5-year average of about -95bp.

Figure 2. France runs one of the largest primary deficits

% of GDP, 2024E

France’s Relative Funding Conditions Shifting compared to Other AA-Scope Rated Sovereigns

France’s sovereign spread to Belgium shifted from negative to positive by early June of this year, to around 10bp, up from -4bp on a five-year average, despite Belgium’s fiscal and political challenges. Similarly, France’s spread to Ireland (recently upgraded by Scope Ratings to AA) has increased since President Macron called the snap elections, up to 30bp from around -6bp on a five-year average from 2019-23 (Figure 3). Ireland benefits from a primary surplus, a moderate and declining level of government debt, and the prospects for significant liquidity buffers in the medium term.

Figure 3. Reversal of France’s spread against Belgium and Ireland

Spread, 10-year government bond yield, basis points

Resilient Economy Exposed to Political Paralysis

Despite the political uncertainty, France’s economy remains resilient with real GDP growth better than expected in Q2 2024, underpinning our revised forecast of 1.0% growth this year, up from of 0.8%, and in line with the 1.1% in 2023. Buoyant private consumption amid lower inflation and improving real incomes is supporting growth.

Moreover, France benefits from highly liquid debt markets, a favourable public debt profile, and safe-haven inflows of investors’ “flight to quality” during times of crisis. Still, despite these credit strengths, progress on supply-side reforms and spending cuts are needed to ensure government debt returns to a firm downward trajectory from the 110.6% of GDP level in 2023.

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Thomas Gillet is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH, and primary analyst on France’s sovereign credit rating. Brian Marly, a senior analyst at Scope, contributed to drafting this comment.