Fiscally bankrupt, France is trapped in economic stagnation.
The immediate issue is the 2026 budget. Prime Minister Sebastien Lecornu resigned due to an inability to negotiate a budget for 2026. Still, President Emmanuel Macron and Lecornu insist that a path to a budget compromise remains possible. Time will tell. However, the political crisis is pushing up interest rates among the countries that make up the European Monetary Union. Through the European Central Bank, the Union backstops France’s sovereign debt. The crisis also weakened the euro relative to the United States dollar.
France’s major problem?
Any budget deal will be a fudge that fails to put France on a path to fiscal stability. France will continue to violate the fiscal deficit limits of the European Union. But France must reduce its annual fiscal deficit to 3% of GDP, or, at least, set a credible path to reaching that level. Next year, regardless of whatever budget agreement is reached, France’s fiscal deficit will exceed 5% of GDP. In addition, France is obligated by its EU membership to enact policies to reduce its total debt from the current 115% of GDP to 60% of GDP. Obviously, this will be impossible. So, expect fudges and more fudges for years to come.
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The French left and populist right want to get rid of the 2023 reforms, which increased the national retirement age from 62 to 64. But repealing the pension reform legislation would increase the deficit by about $3.5 billion USD a year. At the same time, fewer people would be working, so tax collections would be lower. Fewer workers would mean slower economic growth. France is already experiencing an extended period of stagnation.
The other possible area of compromise is to implement a wealth tax on French citizens with a net worth of €100 million/$116 million USD or more. Again, proponents of a wealth tax say that the tax would raise to $23 billion USD a year, but mainstream economists say wealth taxes don’t work. The wealthy simply respond with legal tax avoidance strategies and migrate to lower tax jurisdictions.
The top line is that any budget deal will just delay the inevitable reckoning with financial markets and the ECB’s monetary authorities. At some point, the ECB will force France into austerity. Otherwise, France will drag down Europe’s economy, and France’s politics could actually jeopardize the European Monetary Union.
Indeed, a new U.S. National Bureau of Economic Research paper explains that the EMU is a mechanism for transferring resources from the strong economies of the European Union to the weak periphery economies. Recently, France was considered to be at the center of the EMU. Now France has become a periphery country like Italy and Greece.
France’s crisis will come when countries such as Germany and the Netherlands say, “No more.” The strong countries of the EMU will eventually force the ECB to stop guaranteeing France’s debt. When this inevitably happens, the cost for France to borrow in international markets will soar. At the moment, France’s 10-year sovereign debt carries a very low borrowing cost of about 3.5%.
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If France is forced to borrow without the backstop of the ECB, the cost for France to borrow would probably exceed the borrowing costs of the United Kingdom, around 4.8% for ten-year money. The U.K.’s fiscal and economic picture is dark but significantly brighter than France’s.
The above-noted NBER working paper is a timely and forceful reminder that France does not face default on its sovereign debt only because of the good graces of Germany and the Netherlands. But France is an economic time bomb.
One day, it will detonate.
James Rogan is a former U.S. foreign service officer who has worked in finance and law for 30 years. He writes a daily note on the markets, politics, and society. He can be followed on X and reached at [email protected].