The impacts of fiscal uncertainties in France
Friday, 25 October 2024
The latest Future is Blue episode covers the volatility sweeping EU sovereign debt markets in the wake of France’s election results. In an in-depth conversation with Carlos Carnicero Urabayen, Alice Faibishenko, Senior Advisor at Funcas, sheds light on the financial turbulence triggered by budget uncertainties in France and its effects across the eurozone.
You can listen to our episode here.
The conversation centers around the findings from the recent SEFO Funcas report, which highlights France’s growing fiscal challenges and the broader implications for the European Union. Faibishenko points out that the volatility stems not just from fiscal uncertainty but also from long-standing imbalances in France. “France’s fiscal deficit increased to 5.5% of GDP last year, while its public debt-to-GDP ratio climbed to 110% by the end of 2023,” she explains, underscoring the gravity of the situation. “This really highlights the scale of the problem we're talking about.”
The June 2024 legislative elections sparked renewed fears of political fragmentation. The heightened risk was immediately reflected in sovereign bond spreads, with the gap between French bonds and the benchmark 10-year German Bund widening to 85 basis points. This increase, Faibishenko notes, was driven by market concerns about France’s ability to manage its fiscal situation amid deepening political gridlock.
The risk of Eurozone fragmentation
One of the most pressing concerns raised during the podcast was the risk of eurozone fragmentation—a fear rekindled after France’s elections. Several indicators suggest growing fragmentation risks within the Economic and Monetary Union (EMU). However, the European Central Bank (ECB) is playing a stabilizing role. “Statements by the ECB, particularly from President Lagarde, were crucial in calming the markets between the two rounds of voting,” said Faibishenko. The ECB’s reassurances helped contain the volatility, preventing it from spreading further across the eurozone.
On a positive note, the fallout from France’s debt crisis has not yet fully spilled over into other peripheral economies like Spain and Italy. “What we’re seeing in France is largely idiosyncratic,” she explains.
Limited contagion, but widespread concerns
The contagion from France’s political and financial instability has been relatively contained so far. “In Italy and Spain, the increase in estimated spreads is less pronounced.” Indeed, spreads remain at higher absolute levels in the case of Italy while Spain’s spreads are actually now slightly lower than those of France.This limited contagion contrasts with the severe fallout seen during the 2011-2012 sovereign debt crisis, when instability in one country quickly spread across the eurozone.
The current situation thus suggests that France’s problems are more isolated—at least for now. Still, Faibishenko warns that France’s economic fundamentals are deteriorating. “France has seen a slow but steady decline in its fiscal position, making it look more and more like a periphery economy,” she observes. With a debt-to-GDP ratio on par with countries like Italy and Spain, France’s fiscal sustainability is increasingly in question.
The SEFO Funcas report emphasizes that France’s modest economic growth, combined with high public debt and political uncertainty, presents a serious challenge for the country and the EU. Despite the temporary relief provided by the EU’s flexible fiscal rules, Faibishenko argues that deeper reforms are needed to address these underlying issues. “These fiscal rules may give some breathing space, but they don’t resolve the core fiscal imbalances,” she says.
Looking Ahead: More Volatility on the Horizon?
As France grapples with fiscal challenges, the future of its sovereign debt markets remains uncertain. Volatility in France’s risk premiums, and those of other eurozone issuers, could become a recurring feature, rather than a temporary phenomenon. “With economic cooling and political polarization, we could see upward pressure on sovereign debt spreads across the eurozone,” she cautions.
Looking ahead, Faibishenko stresses the need for governments to implement long-term solutions. “It’s going to require a careful navigation of fiscal and economic reforms, not just for France but for many EU countries facing similar challenges,” she concludes.
As the EU reinstates its fiscal rules, France and other member states will need to balance their fiscal responsibilities with the realities of a slower-growing economy and an increasingly fragmented political landscape. The future of the eurozone may depend on how well these countries manage to stabilize their debt ratios and regain market confidence.
You can listen to the episode here.
Carlos Carnicero Urabayen