France is going through a historical period in which financial indiscipline, political problems and street protests are simultaneously deepening. While the structural decline in public finances brought the country's borrowing costs in the bond markets to the highest level in recent years, the common currency euro fell to 1.116, the lowest level of about 1.5 years against the dollar in global markets.
Economists are discussing whether this negative situation, which started in Paris and is growing rapidly, will trigger a new debt crisis that will surround the Eurozone.
The French economy is in a structural debt trap
According to French National Institute of Statistics (INSEE) and government data, the country's overall public deficit reached 5.8 percent of Gross Domestic Product (GDP), exceeding the European Union's (EU) 3 percent ceiling. The public deficit in question is aimed to be reduced to 5 percent in 2027.
In the country, which has not had a budget surplus since 1974, public expenditures are constantly increasing structurally, despite the slow growth of tax revenues. More than half of the 1.3 trillion euros added to the debt stock since 2017 comes from expenses arising from the Covid-19 epidemic and energy crises, and the rest comes from tax cuts for households and companies.
As a result of these chronic budget deficits, the ratio of France's total public debt to GDP is expected to rise to 121.7 percent in 2027. Today, the country's total nominal debt stock has reached a historical peak of 3.596 trillion euros, corresponding to 119 percent of GDP. While this debt has reached the highest level since 1945, it also threatens macroeconomic stability.
According to analysts, the French economy has fallen into a structural debt trap where nominal growth rates remain below borrowing rates. It is also noteworthy that the ratio of France's public debt to GDP exceeds twice the 60 percent limit, which is the Maastricht criterion.
While this situation in France escalates the 'contagion risk' caused by the budget deficit in the European bond market, analysts point out that the selling pressure that the Paris administration is exposed to due to the high debt burden and budget deficit has started to spread to other Eurozone countries such as Italy, Belgium and Greece.
Interest burden became the largest item in the budget
While the structural gap between France's public revenues and expenditures forces the country to borrow from the markets every year, this situation is directly reflected in borrowing costs. With global tightening and loss of investors' confidence, borrowing interest rates, which were close to zero in 2020, climbed to 4.5 percent.
Due to this increase in the cost of debt servicing, France's annual interest payments are expected to reach 65 billion euros (about 7 percent of the budget).
With this figure, the debt interest burden becomes the largest single expenditure item of the state budget, surpassing primary and secondary education expenditures for the first time in the country's history.
Analysts warn that keeping the nominal growth rate below borrowing rates is dragging the country into a dangerous "snowball effect" that requires borrowing more to pay interest.
Reaction to budget cuts in the streets
The minority government, led by Prime Minister Sébastien Lecornu, had prepared a radical austerity package worth 54 billion euros in order to gradually reduce the budget deficit to 5 percent by 2027.
However, this savings program prepared by the government to ensure financial discipline encountered very harsh social resistance on the street. Following firefighters and public employees reacting to budget cuts, high school and university students also took to the streets en masse. The protests launched in front of educational institutions have been continuing for days, demanding an end to the teacher shortage, inadequate educational conditions and lack of physical investment in schools that have been going on for years.
While high school students continue their protests demanding more budget for education, they block the entrances of high schools with barricades. Garbage containers were set on fire in front of some schools, while barricades were set up on main roads in some cities. The police's use of pepper gas and rubber bullets against students at demonstration points and their physical intervention caused a harsh reaction from the opposition wing. Within the scope of the actions, 170 students, 65 education personnel and more than 600 law enforcement officers have been injured so far, while legal action has been taken against more than 5 thousand people. Face-to-face education was suspended in 400 schools, corresponding to approximately 10 percent of high schools across the country.
Inflation erodes purchasing power
European Union (EU)-compliant annual inflation in France continued to seriously erode household purchasing power, rising from 2.6 percent to 3.4 percent in September as the situation in the Middle East triggered oil and natural gas prices.
Energy prices increased by 21.2 percent on an annual basis in September, becoming the main reason for the increase in inflation. The Yellow Vest Movement, which reorganized after the price increases, demanded an increase in the education budget, as well as freezing energy prices and imposing additional taxes on large companies.
As President Emmanuel Macron's term nears its end, opposition parties are staunchly resisting unpopular budget cuts in parliament. The government's effort to enact the budget, which does not have a parliamentary majority, is dragging the country into a deep political crisis.
Political crisis puts pressure on the euro
In addition, the euro started the new trading week with a sharp depreciation in global markets, falling below the psychological limit of $ 1.12.
Analysts directly attribute the loss of blood in the parity to the increasing concerns about Paris' public finances, the widening interest rate gap between the USA and Europe and rising oil prices.
Thu Lan Nguyen, Head of Foreign Exchange and Commodity Research at Commerzbank, said: "The euro, which has been largely unaffected by the fluctuations in the bond markets in the past months, is now at the center of these concerns. Investors' concerns are no longer limited to France alone."
2012 debt crisis warning in bond market
The deep uneasiness in the bond market was directly reflected in the risk premiums of countries. The interest rate spread between France and Germany's 10-year government bonds widened by 32 basis points last week, reaching 141 basis points, and pushed to 150 basis points yesterday. This increase was recorded as the largest weekly expansion recorded since 1990.
ING Developed Markets Economist James Smith stated that there is a great impasse in reducing the budget deficit below 6 percent due to France's fragmented political structure.
In another joint analysis prepared by other economists of the institution, it was pointed out that the new budget plan of 54 billion euros presented by the minority government will not create a permanent relief in the bond markets.
Deutsche Bank Analyst Jim Reid asked, "The real question is whether this is the beginning of a new euro debt crisis or whether the markets are overreacting," and argued that the markets will continue to force political decision-makers to take concrete steps.
