By Cary Springfield, International Banker
On May 31, S&P Global Ratings lowered its long-term sovereign credit rating for France to ‘AA-‘ from ‘AA’, largely in response to the government’s failure to manage its public finances sufficiently amid its widening budget deficit. And with the administration of President Emmanuel Macron having lost its governing majority in the snap election concluded on July 7, concerns over France’s deficit and debt levels continue to grow.
The downgrade should come as no surprise to France. After all, fellow credit-rating firm Fitch Ratings took similar action in April 2023 when it slashed the country’s sovereign rating to ‘AA-‘ from ‘AA’, its justification being that France’s fiscal metrics were weaker than those of its peer nations. As such, Fitch expected the ratio of general government debt to gross domestic product (GDP) to “remain on a modest upward trend, reflecting relatively large fiscal deficits and only modest progress with fiscal consolidation”. Fast forward one year, and Fitch reaffirmed its view in April 2024 by leaving its rating unchanged at “AA−” with a stable outlook.
S&P’s downgrade followed around one month later, which the credit-rating firm attributed to its updated forecasts that “France’s general government debt as a share of GDP will increase as a result of larger-than-expected budget deficits over 2023-2027”. Thanks largely to much lower-than-expected tax receipts last year, France recorded a government budget deficit equal to 5.5 percent of GDP for 2023—well above analysts’ estimates and sizeably more than the 4.8 percent recorded in 2022. And with many predicting that efforts to rein in the deficit over the coming years will prove inadequate to meet the European Union (EU)-mandated ceiling of 3 percent by 2027 for all member states, further downgrades may well loom large in the coming years.
The European Commission (EC) has been highly critical of the worsening state of France’s public finances, with its national debt—currently more than 110 percent of GDP—nearly double that of the level permitted by the European Union and the third-highest in the EU after Greece and Italy. It confirmed in June that it would open an excessive deficit procedure (EDP) due to Paris’s failure to maintain its budget deficit within 3 percent of GDP, adding that while the public-debt-to-GDP ratio had edged down “somewhat” with the recovery in GDP since 2021 and while the ratio is projected to remain broadly stable in 2024, it will increase again in 2025 “amid continued large government deficits”.
Such withering assessments, therefore, have loudened calls for Paris to sort its finances out posthaste. The International Monetary Fund (IMF), for example, has pressed France to adopt more prudent policies to resolve its debt problems, warning that the budget deficit will swell well above forecasts by 2027. The Fund has predicted the deficit to reach 5.3 percent of GDP this year, which is higher than the 5.1 percent slated by the government. But it also expects the budgetary shortfall by 2027 to be “significantly higher” than government projections: 4.5 percent versus Paris’s 2.9 percent, as stated in its 2024 Stability Programme update. “Further consolidation measures are recommended over the medium term, starting in 2024, to bring debt on a downward trajectory while making space for targeted growth-enhancing spending,” the IMF stated on May 23, following its staff mission visit to France.
The government has pledged to slash its public-sector budget deficit from 5.1 percent of GDP this year to 4.1 percent next year as it scrambles to put France on a more solid footing to meet the EU’s Stability and Growth Pact (SGP) target of 3 percent by 2027, an initiative that was put on hold by the economic fallout from the coronavirus pandemic and the outbreak of war in Ukraine. Finance Minister Bruno Le Maire recently acknowledged that projected spending cuts this year will total $27.1 billion to lower the deficit sufficiently in pursuit of its 2027 goals. Le Maire also stated previously that the credit-rating agencies’ concerns should “encourage us to redouble our determination to restore our public finances and meet the objective” of bringing the deficit below 3.0 percent by 2027. “We will keep to our strategy based on growth and full employment, structural reforms, and the reduction of public spending.”
To its credit, the government received praise from the IMF for its “realistic and ambitious” goal to lower the deficit. “Despite ongoing growth-enhancing structural efforts, the macroeconomic assumptions underlying the government’s plan might prove somewhat optimistic over the adjustment period.” Nonetheless, most analysts still expect France to struggle to meet its 2027 deficit target of 2.9 percent.
Moody’s Ratings stated in late April that it was “unlikely” that France would achieve its objectives. “Progress in sustainably reducing the budget deficit and government debt is limited,” it explained, adding that its public debt could reach almost 115 percent of GDP by 2027 and that France’s interest burden “will gradually rise and could double over the next decade if the debt level does not materially decline”. Fitch similarly confirmed at the time that “it will be difficult to achieve this target as deficit narrowing measures remain largely unspecified, [and] France has only met the 3 percent deficit criterion in four out of the last 20 years”. While both firms left their sovereign ratings for France unchanged at the time, moreover, they also expressed scepticism over Paris’s ability to reduce its overall public-debt pile sufficiently.
S&P’s forecasts, meanwhile, have projected France’s budget deficits to average 4.6 percent of GDP during the 2024-26 period, which is higher than its previous December 2023 estimate of 3.9 percent. By 2027, the rating agency predicted the ratio to decline to 3.5 percent of GDP, which would remain comfortably above the government’s 2.9-percent target, with lower economic growth forecasts for France between 2024 and 2027 cited as the main explanatory factor for this failure. “We believe the French economy and public finances overall will continue to benefit from structural reforms implemented over the past decade,” S&P noted in its May 31 downgrade report. “However, without additional budget-deficit-reducing measures, in our view, the reforms will not be sufficient for the country to meet its budgetary targets.”
S&P also forecasted France’s general government debt (excluding guarantees related to the European Financial Stability Facility [EFSF]) to reach 112.1 percent of GDP in 2027, with the tightening of the European Central Bank’s (ECB’s) monetary policy playing a crucial role in raising financing costs for the government. As such, general government interest payments are projected to average 4.3 percent of general government revenue from 2024 to 2027, compared with 3.3 percent in 2023. “Because the average maturity of French central government debt is 8.5 years and the average interest rate on the outstanding debt is low at about 2 percent, the impact of higher market interest rates on the cost of debt will be gradual,” S&P also acknowledged.
To compound matters, its decidedly fragmented political environment is further preventing France from resolving its debt woes, which, according to S&P, adds to the uncertainty regarding the government’s ability to continue implementing policies that increase economic-growth potential while addressing budgetary imbalances. “Without an absolute parliamentary majority, the government continues to face strong parliamentary and nonparliamentary opposition to some reform proposals—as demonstrated by widespread protests and strikes against the pension reform in first-half 2023.”
Does the July 7 election result—which saw the left-wing New Popular Front (NFP) coalition spearheaded by Jean-Luc Mélenchon win the largest share of the 577-seat French Parliament with 182 seats—significantly transform the calculus on France’s debt and deficit challenges? With negotiations ongoing to form a government amid a hung Parliament, many analysts are suggesting that France’s new political reality is unlikely to ease its fraught fiscal situation in any significant manner. “A divided National Assembly will find it hard to agree on politically difficult spending cuts,” Leo Barincou, senior economist at Oxford Economics, told Reuterson July 10. “This will put France on a collision path with the EU’s new fiscal rules.”
Indeed, some fear that an NFP-led government could worsen France’s gaping deficit. The party promised on the campaign trail to raise government spending by €150 billion, as well as hike public-sector wages and enact housing subsidies. “Mélenchon is not as well-known outside of French politics as [the far-right National Rally’s] Marine Le Pen, but he and the other leaders of the leftist alliance have proposed a program that includes big increases in public spending, rolling back the retirement age and other policies that are at odds with the EU—and are estimated to cost an additional 179 billion euro [$194 billion], according to the Institut Montaigne,” Tina Fordham, founder of Fordham Global Foresight, noted. “Market-friendly they are not.”
As for Mélenchon himself, however, raising taxes is the definitive solution for combatting France’s excessive deficit over the long term. “I can tell you that there is not a new expense—and I make a commitment to you on behalf of the coalition, and not just on my own behalf—… not an additional expense that is not guaranteed by additional revenue,” he recently stated. “Neoliberal policies create debt and social disruption. It’s clear, therefore, that things are bound to go worse for France, having been a state-run economy for a millennium, than for other states when we disrupt the state and public services and the major institutions of social solidarity.”