Finding a way out: the debt crisis in France could shake the whole of Europe
The French national debt is on the verge of an acute crisis: The yield spread between the country's 10-year bonds and Germany's "exemplary" EU debts has reached its highest level in 15 years. The debts of the Fifth Republic are actually listed as "junk". All this coincided with the intensifying political and street confrontation in the country, the energy shock and the lack of prospects for economic growth. Paris is facing a full-fledged debt crisis that could spread to the whole of Europe. The situation is already being compared to the Greek collapse of the early 2010s, with the only difference being that the collapse of French state finances could be an order of magnitude more dangerous. Details can be found in the Izvestia article.
Non-compliance with standards
For more than 25 years of the history of the single European currency, French government bonds have been perceived by investors as an unconditional protective asset. The Fifth Republic was one of the two main pillars of the EU, and the market assumed that Paris, despite periodic economic difficulties and a rich tradition of social protests, would always find a way to balance the budget. Now there are questions about this.
Overall, France's economic performance does not look great. The ratio of public debt to GDP has approached 120%, which is almost twice as high as in Germany. But the figure itself is half the battle, and what's worse is that the government is unable to control current spending. Initially, it was assumed that the French budget deficit would decrease in 2026, but reality forced us to reconsider our plans: the expected figure for the current year will be 5.4% of GDP. The Maastricht criterion for budget discipline, which is used to judge the success of new EU members, is 3%. The government's draft budget for 2027 aims to reduce the deficit to 5%. In other words, there is no question of meeting our own standards.
However, the independent Supreme Council for Public Finance of France (HCFP) criticized this document as well. The auditors' main complaint is that the government has budgeted for accelerating economic growth from 0.5% in 2026 to 1% in 2027. This forecast looks divorced from reality. The Organization for Economic Cooperation and Development expects an increase of only 0.7%, and current leading indicators such as industrial business sentiment or new orders also do not give reasons for optimism.
HCFP Chairman Amélie de Monchalin called what is happening "a crisis deficit in the absence of the crisis itself." That is, during the usual period of the economic cycle (albeit a sluggish one), the government spends as if it were necessary to amortize an acute recession. The authorities' plan to increase GDP and, consequently, budget revenues implies a sharp increase in private investment, which is hardly realistic given the rising cost of borrowed capital for the corporate sector and households. Already today, France's public debt servicing costs (80-90 billion euros) exceed the amount of funds allocated for national defense or education.
The effect of infection
The reaction of capital markets to the fiscal policy of the government of President Emmanuel Macron has been rapid. The yield on France's 10-year government bonds reached 4.9%, the highest since 2002. The spread between French 10-year securities and benchmark German Bunds broke through 152 basis points. Capital is flowing into German assets, perceived as the last safe haven on the continent (although they raise questions, but there is already a choice of the lesser of evils), leaving French securities as a toy for speculators. Lower liquidity, more risky investors, higher volatility.
Of course, all this is not limited to France. The fall in the value of French bonds dragged down the debt securities of Italy, Belgium, Spain and Greece. Countries with high debt levels have proven to be extremely vulnerable in a world of high interest rates. As Bloomberg notes, global fixed income funds have begun to completely liquidate their positions in French sovereign bonds, fearing further uncontrollable collapse. Additional pressure is exerted by hedge funds, which massively close carry-trade transactions and get rid of positions with leverage.
The weakening of the debt market is hitting the EU single currency. The euro fell to 1.1161 per dollar in Asian trading, reaching the lows of May 2025. Investors are pricing in the risks that fiscal problems in the peripheral and core economies of the EU will lead to long-term instability in the entire region.
The energy catalyst
France's financial problems are magnified many times by the external macroeconomic background. The escalation of the conflict in the Middle East and supply disruptions through the Strait of Hormuz have provoked a new round of rising energy prices.
Expensive oil and instability in the gas market translate into steady cost inflation. Normally, an economic downturn in France would require the ECB to cut interest rates to boost growth. But imported energy inflation is tying the hands of the regulator in Frankfurt. The EU Bank is forced to keep rates at high levels in order to prevent price acceleration.
For France, this means that refinancing of the huge public debt will take place at extremely high rates. This, in turn, spins the following spiral: rising interest payments increase the budget deficit, which requires the issuance of new bonds, which investors agree to buy only at an even greater risk premium.
Political paralysis
Any attempts by the government to make drastic spending cuts are shattered by the domestic political reality. The Cabinet of Ministers does not have a stable majority in the "suspended parliament", which has already become accustomed to scaring the markets by regularly sending prime ministers to resign. Street protests like the ones we see performed by schoolchildren this week also do not add stability and confidence in the future.
Potential shocks in the French bond market were previously expected after the elections in May 2027, but, apparently, they begin much earlier (and it will not be possible to blame the crisis on the victory of "non-systemic" forces). It is difficult to predict the election results in advance, but judging by current polls, the era of Macron's conditionally centrist rule is ending. Marine Le Pen, the leader of the right-wing National Union parliamentary faction, and Jean-Luc Melenchon, the founder of the far-left Unconquered France party, may enter the second round. The opposition does not show the slightest desire to compromise with the outgoing administration. The presence of Melenchon, who previously called for the cancellation of French debts held by central banks, causes considerable nervousness among international creditors. Le Pen is more reliable from the point of view of state finances and, moreover, is trying to build bridges with business, but her program will also require considerable sacrifices.
Comparisons of the current situation with the Greek crisis of the beginning of the last decade are becoming more frequent. But Greece was a peripheral economy, whose default, for all its pain, could be stopped with financial injections from pan-European funds. France is the second economy of the European Union. The volume of its debt market is so large that Brussels and Frankfurt do not physically have a firewall of sufficient size to save it.
The ECB's options are extremely limited. The regulator has a Transmission Protection Tool (TPI) created in 2022, an unlimited bond purchase program to prevent "unjustified" market fragmentation. The difficulty lies in the fact that the application of TPI requires compliance with fiscal discipline by the country. France's problems are man-made and are a direct consequence of the political elites' unwillingness to live within their means. The launch of a printing press to buy back French debts will cause categorical rejection in Germany and the Nordic countries, as well as lead to a new surge in inflation in the eurozone.
An alternative step could be to stop the quantitative tightening program, which would reduce the market supply of securities. However, this would only relieve the symptoms for a very short time, without eliminating the cause of the disease.
More than two decades of living in debt, coupled with expensive energy resources and internal political polarization, have deprived France of immunity to market shocks. Without a radical overhaul of public spending and painful reforms that the current elite is unlikely to be ready for, Paris risks triggering a chain reaction. An extreme option (still unlikely, but who knows what will happen in a year or two) may be a full-fledged sovereign default within the core economy of the EU, the consequences of which will lead to a fundamental revision of the entire eurozone system.
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