France is at risk of being plunged into fresh political turmoil as its minority government teeters on the brink of collapse amid opposition anger over a planned austerity budget.
Reflecting growing unease in financial markets, French sovereign borrowing costs have risen sharply, reaching the highest premium over German bonds since the height of the eurozone debt crisis in 2012.
At the heart of the dispute is the prime minister Michel Barnier’s plans for a budget involving €60bn (£50bn) of spending cuts and tax rises despite lacking a majority in parliament, leading to threats from the French far-right leader, Marine Le Pen, to topple the government.
On Thursday, Barnier made a key concession by dropping plans to raise a tax on electricity. But while the far-right National Rally president, Jordan Bardella, claimed a “victory” over the step, he warned “other red lines remain”.
What is happening in markets?
On Wednesday the gap between French sovereign borrowing costs and those of Germany widened to as much as 90 basis points, the biggest split since 2012. Shares on the Paris stock exchange also tumbled.
The yield – in effect the interest rate – on 10-year French government bonds briefly rose above those of Greece for the first time on Thursday amid investor concerns that the government falling could trigger a fresh period of political chaos.
Later on Thursday the yield on French bonds fell back slightly after the finance minister, Antoine Armand, said the government was ready to make some concessions over the budget.
What is France’s budget plan?
After snap elections held by Emmanuel Macron this summer, the new minority government is under pressure to steady the public finances from the EU and financial markets after warning that its budget deficit – the gap between spending and tax income – would exceed 6% of gross domestic product (GDP) this year.
Last month Barnier announced cuts for welfare, health, pensions and local governments, as well as tax rises, including the restoration of a levy on electricity consumption that was suspended in the energy crisis.
Under the plan, borrowing could be cut to 5% of GDP next year, but without that action it could reach almost 7%. That would be more than double a 3% limit in the EU’s stability and growth pact, which is designed to ensure member states pursue “sound public finances” and coordinate their tax and spending plans.
Brussels has placed France under an “excessive deficit” monitoring process. While several others are in this position – including Belgium, Italy and Poland – investors fear France could maintain unsustainable plans.
Why have borrowing levels risen?
Borrowing rose sharply after the Covid pandemic and Russia’s war in Ukraine triggered a global inflation shock, as the government stepped in to protect households and businesses, while weaker economic activity sapped tax receipts.
However, analysts also said tax cuts launched by Macron under his reformist agenda to inject more free-market dynamism into the French economy had undermined the stability of public finances.
Léo Barincou, a senior economist at the advisory firm Oxford Economics, said: “The key reason for the current precarious fiscal situation really has to do with unfunded tax cuts under Macron.”
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Viewed as a business-friendly centrist, the former Rothschild banker’s economic agenda included discretionary tax cuts adding up to €65bn since 2017, which have not been matched by equivalent cuts in public spending.
The headline rate of corporate tax was cut from 33% to 25%, while a “solidarity tax” on wealth, levied on assets above €1.31m, was replaced with a far lower 30% tax on capital gains from interest and dividends.
However, tax as a share of national income – despite having come down in recent years – remains at the highest level in the Organisation for Economic Co-operation and Development. Spending is also at the highest level in the group of 38 rich countries.
Andrew Kenningham, the chief Europe economist at the research firm Capital Economics, said France faced long-term problems, including pension spending at 15% of GDP, and a “political culture which makes expenditure cuts difficult”.
In addition to structural challenges, France has faced continued weak household consumption – suppressing VAT receipts – while local government spending had been higher than expected.
What happens if the government is brought down?
Barnier has said toppling the government could cause a “big storm and very serious turbulence” in financial markets.
Some commentators warn France is heading for a Greek-style debt crisis, referencing the near implosion of the eurozone in 2012, when Athens was forced to seek a bailout from the EU and International Monetary Fund.
“Comparisons with Greece are completely overblown,” Kenningham said. “France has major fiscal problems but is not going to default or cause a huge eurozone crisis anytime soon.”
Some observers say a compromise is likely, suggesting that although Barnier’s proposals are unpopular, his critics would struggle to come up with alternative plans if they brought down the government.
Barincou said a softer budget package was likely, with markets expecting a deal allowing the deficit to be reduced to about 5.5% next year, rather than 5%. However, there is a danger that opposition lawmakers could still reject any agreement.
“Markets are concerned about the possibility of the Barnier government being overthrown. Then basically it would be more or less chaos. The French could start the year without a budget.”