With demonstrations set to resume this weekend in France over the high cost of living and deteriorating school conditions, the government is still trying to contain growing turmoil in its bond market.
This week, investors continued to shun French debt, pushing the yield on 10-year bonds above 5 percent for the first time since 2002, raising the cost of public borrowing. The government got a small respite late on Friday, after the ratings agency Moody’s held the country’s credit rating at Aa3, skirting the possibility of a small downgrade.
But Moody’s noted that the outlook remains negative and that France still needs a “significant and sustained fiscal effort” to stabilize its debt burden.
Concerns about France’s public finances have been building for years, but the situation has escalated in the past several months as borrowing costs rose around the world. That has exposed France’s vulnerability in markets. The country’s debt has grown quickly in recent years and is expected to exceed 120 percent the size of its economy next year.
With no imminent government plan to rein in borrowing, France’s debt interest bill will jump further, competing with the many other demands on France’s budget, from additional funding for schools to pensions for an aging population.
Several crises are starting to play out at once. Political gridlock ahead of presidential elections next spring is making it difficult for the government to pass a budget that would even modestly reduce the budget deficit next year. On top of that, protests over the cost of living are also making the prospect of fiscal tightening — in the form of spending cuts or tax rises — less unlikely. Many of those demonstrations turned violent last week.
“The 2027 budget process coincides with some of the most extensive social protests France has experienced in many years,” Moody’s noted in a statement.
Moody’s has kept France’s investment grade rating slightly higher than those by Fitch and S&P, two other large ratings agencies, which both downgraded the country last year. An investment grade rating signals a determination that a creditor has a relatively low risk of default.
In a sign of the negative sentiment, investors are demanding much higher premiums to lend to France over Germany, which is considered Europe’s safest asset. The spread between French and German 10-year bond yields is the widest since 2011, during the depths of the eurozone sovereign debt crisis. The gap has doubled in just two months, an alarming rate.
The challenge for France is that its problems are starting to feed off each other and risk becoming a self-fulfilling spiral.
The economy was already weak this year, with a contraction in the first quarter and stagnation in the second quarter. The protests and looting this month are expected to weigh on growth further. And low economic growth is making the debt situation harder to manage.
France is entering “a long period of uncertainty” through the spring and summer next year, said Charlotte de Montpellier, an economist at ING bank. The political stalemate may imperil the passage of a budget that would shrink the deficit. Without a new budget, the deficit would balloon and exacerbate the debt burden. “This is completely bad timing,” she said.
Moody’s said it expected the current government to pass a new budget, even if it had to be forced through, but added that the next president and government would need to reduce the deficit more firmly.
Still, Moody’s was doubtful about the prospects of substantial change because of social tensions and low economic growth. “As a result, the debt burden will continue to rise through the remainder of the decade,” the ratings agency said.
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