France’s political chaos reveals fiscal weakness

This article was written on 21 December 2024

Politics has not been kind to France this year. In 2024, it has had four prime ministers leading four minority governments, a collapse of centrist politics, and multiple protests. These political issues came to a head with the recent budget crisis. How did France get here?

This June, the European Union (EU) held its parliamentary elections, where member states elected MEPs to the EU’s legislative body. In France, the National Rally (RN) – a right-wing populist party – won over 31% of the vote and a plurality of French MEP seats, beating Ensemble, the coalition created by President Macron, which received just over 14% of the vote. This shock result led Macron to take a big gamble by dissolving the National Assembly, the lower house of the French Parliament, and calling a snap election in the same month. The gamble did not pay off. The left-wing New Popular Front (NFP) alliance won a plurality of seats, with Ensemble coming in second and the RN in third. However, neither of the three blocs came close to winning a majority of seats.

Macron had already lost his parliamentary majority in 2022, but this election made him even weaker, with Ensemble losing the most seats. In his second term, his government had to repeatedly force through bills (like the controversial increase in the state pension age), using Article 49.3 of the French Constitution, which allows the government to force legislation through the National Assembly without a vote.

In this weaker context, it took until September 2024 for Macron to appoint Michel Barnier as prime minister – a right-wing conservative from outside of the Ensemble coalition. Barnier’s first big task was to ratify a 2025 budget for France.

[France’s government] debt-to-GDP ratio stands at over 110%, more than 50% above EU limits

Fiscally, France is plagued with problems. Its deficit sits at 6.1% of GDP: double the EU limit. Moreover, its debt-to-GDP ratio stands at over 110%, more than 50% above EU limits. The ideological division in parliament made it difficult for Barnier to tackle these problems.

After a series of negotiations with both the NFP and RN, Barnier proposed a budget with €20 billion of tax hikes and €40 billion of spending cuts, aiming to bring the deficit closer to 5% of GDP. As has been common in Macron’s presidency, Barnier tried to force through this budget using Article 49.3, avoiding a parliamentary vote. This time, however, the NFP and RN joined forces to pass a no-confidence vote, ending the shortest-living government in French history.

Since then, Macron has appointed Francois Bayrou, a centrist, as prime minister, but the 2025 budget remains an unresolved issue. On 16 December, The National Assembly approved a special bill rolling over the 2024 budget to avoid a government shutdown until (and if) it approves a budget drafted by the Bayrou government. Macron’s hands are tied, as there must be at least a one-year gap between another snap election and the last one, creating friction with parliament.

The Bank of France has cut France’s 2025 growth outlook from 1.2% to 0.9%, and Moody’s unexpectedly cut France’s credit rating from Aa3 to Aa2 on 13 December, noting that France will not be able to rein in its budget deficit. Recent business climate data is at a five-month low, reflecting the deteriorating economic environment.

This whole situation reflects the failure of the EU’s fiscal rules

The yield on France’s 10-year government bonds (OATs) has risen above 3.1%, their highest level in almost a month. Furthermore, the French-German 10-year spread has risen to 80bps – the highest in over a decade. Thankfully for the European Central Bank, there is no evidence of economic contagion in the Eurozone, with the spreads for Italian, Greek, and Spanish bonds continuing to tighten against German ones. In theory, France’s risk premium is close to that of Greece (at 89bps) reflecting the evolving nature of the European government bond market since the 2010s sovereign debt crisis.

Longer term, it is likely a significant political risk premium will remain in the OAT market. Even once a budget is passed, the National Assembly is split three ways. Furthermore, the French economy, and EU, have growth problems, further hurting fiscal sustainability. Higher yields, and the credit downgrade, will hurt financing investment costs for French businesses. The CAC 40, France’s benchmark equity index, has fallen for the past two consecutive weeks but has been more broadly affected by international macroeconomic news, like Chinese competition and tariff threats, due to the global nature of index firms like LVMH and Airbus. Continued political gridlock in France, and a weak Germany, will continue to weaken the Euro, even before Trump fleshes out his EU tariff policy.

Overall, this whole situation reflects the failure of the EU’s fiscal rules. Even with France being under the EU’s Excessive Debt Procedure (EDP) programme, it has failed to maintain fiscal discipline, culminating in the current situation. With Trump’s return looming, it seems unlikely that the EU will punish France beyond EDP programme fines, and the EU is lucky that the French bond market frenzy has not spread to other countries – many of which lack stable governments and have rising fiscal deficits. It is difficult to see how Bayrou will succeed, given the fundamental political conditions have not changed, and therefore it is likely we will see continued volatility in France in 2025.