Article

French bonds, an election and excessive deficits

French President Emmanuel Macron faces poor opinion polls and European Union criticism of his borrowing level.

| 5 min read

Emmanuel Macron must have been disappointed with the early polls suggesting his surprise early election would see heavy losses for his centrist supporters in the National Assembly. The news just got worse this week, with the European Union (EU) deciding France, alongside Italy, Malta, Belgium and Slovakia and the difficult duo of Hungary and Poland, was going to be put through its excessive-deficit procedure.

This system of budgetary control was suspended until late last year allowing countries to run up large debts over the Covid-19 lockdown period and the recovery phase that followed. Slowly, the EU is going back to its old attempts to control deficits and debts – though this time they are allowing more flexibility for individual countries and longer time frames to get back to virtue.

What is the excessive deficit procedure?

The EU Treaty (Article 126) binds its member states to keep state debt to 60% of GDP or less. They need to keep their budget deficits each year to less than 3% unless there is a recession or some big external shock.

Many countries have stayed well above the 60% target for debt – and many have exceeded the 3% level. The revised deficit rules allow temporary excesses. It has not yet reintroduced the 60% state-debt control and will do so in due course by seeking to control spending if a country is persistently above 60%. It will expect a plan to get the state debt levels down. Countries will be given a net expenditure path. These current excessive deficit procedures relate just to the annual deficits.

The legal base for EU action is the treaty itself, fleshed out by Regulation 1467/97 and amended by EU 2024/1264 and Council Directive 2024/1265. The offending countries have had to accept these procedures as a way of implementing the treaty. There is no wish to seek to amend the Treaty again given the difficulties this creates with complex and time-consuming procedures for ratification and the need for some countries to hold referendums.

The EU studied 12 states that it thought might be over the deficit levels. It found two were not and three were temporary astray. This left seven that it decided were in default. The two largest are France and Italy. Their numbers are reviewed below:

Italy and France in significant breach

As euro members, the level of debt and the rate of increase in debt is of particular importance to other member states. They are all borrowing at rates related to the same European Central Bank (ECB) set base rate. National longer-term rates vary from the average, reflecting the different perceptions of debt burden and credit worthiness.

The euro authorities are very worried if the rates get too high for individual member states, creating tensions in government bond markets and creating losses in the portfolio of bonds the euro system has bought during quantitative easing. ECB President Christine Lagarde learned early on she had to try to minimise divergencies between the longer-term interest rates of members and keep orderly markets.

Germany has traditionally led the more prudent group of countries which do not want heavily indebted states freeriding on the better average credit rating the low debt countries create. The French state is seeking to spend more and to keep taxes down at a time of populist insurgency, seeking both those outcomes. Faster growth would help but is proving elusive.

Likely outcomes

France and Italy will be required to offer some spending cuts or tax rises to make the numbers look better. The EU has the legal power to fine a state for non-compliance. It is reluctant to do so, as this makes the deficit worse and adds to the tensions within the union meetings.

The EU needs to complete its work on net spending pathways to be able to review the state debt as well as the deficit criteria. The new system has more loopholes. Investment in green transition gives some more flexibility, which France will probably argue. Increasing defence budgets at a time of European war is also looked on more leniently. Italy’s defence spending is well below the Nato target of 2% of GDP, and France has been struggling to hit the target. The options of higher taxes or lower spending are seen as politically difficult.

The polls remain against President Macron.

The polls remain against President Macron. National Rally have said they will not seek to force him out, and he is entitled to serve out his full term until 2027. It looks, however, as if his bid to enhance his power and arrest the march of National Rally is not going to work well. Wrestling with big budget issues and trying to work with a Prime Minister who does not support him or who lacks a majority would add to the complications.

Markets have marked down French bonds a bit to reflect the greater political risks and the continuing problem of the French borrowing requirement. Italy has received substantial EU grant help recently but also faces difficult budget and political choices ahead.

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French bonds, an election and excessive deficits

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