France, an Economic Powerhouse Cutting '10 Billion Euros' Budget [Seungseop Song's Financial Light]

France Cuts Defense Budget Amid Austerity
1% Growth Barely Achieved... Falling French Economy
COVID-19 and Russia-Ukraine War Drive Up National Spending
Risk of Credit Downgrade if EU Fiscal Rules Are Violated

France is staggering. Since last summer, it has been continuously announcing plans to cut its budget. The growth rate keeps declining as well. How did the world's 7th largest economy end up in crisis? Why did it pull out the 'budget cut' card as a solution?

The French government decided on the 19th to cut this year's budget by 10 billion euros. This is a huge amount, exceeding 14 trillion Korean won. Half of the reduced budget is taken up by government ministries. Budgets for major institutions including education, judiciary, and defense were sharply cut. The rest is environmental budget. Subsidies for housing renovations aimed at reducing carbon emissions were restructured. The international aid budget that supported underdeveloped countries was also reduced. However, medical and local government budgets were not cut.

France has been drastically cutting its budget since last year. In July last year, the French government submitted the 2024 budget proposal to the National Assembly. However, the budget size was reduced by 4.2 billion euros. It was the first time since 2015 that the French government reduced government spending. But two months later, in September, plans to further cut the budget were announced. The scale of budget cuts reached a staggering 16 billion euros. By abolishing the electricity and gas price caps, 10 billion euros were saved, and by reducing state support for companies, 4.5 billion euros were cut. Labor market support measures and unemployment benefit expenditures were also eliminated.

Euro sculpture in front of the European Central Bank (ECB) in Frankfurt, Germany. The photo is unrelated to the article content. [Image source=Yonhap News]

Why is France cutting its budget? The French government explained it as 'because it cannot grow.' France estimates its economic growth rate this year at 1%. It originally expected 1.4%, but lowered it by 0.4 percentage points due to worse-than-expected economic conditions. According to major foreign media such as The New York Times, Bruno Le Maire, the French Minister of Finance responsible for the national budget, appeared in a news briefing on the 18th local time to explain the budget cuts. Minister Le Maire emphasized, “A low growth rate means reduced tax revenue, so the government must reduce spending.”

Geopolitical reasons lie behind the decline in France's economic growth rate. The war between Russia and Ukraine, which began in February 2022, has continued for over two years. Instability in the Middle East is also escalating with the war between Israel and the Palestinian armed group Hamas and airstrikes by the Houthi rebels. On top of this, China's economic slowdown and Germany's recession have overlapped. The European Commission has already lowered France's growth rate this year from 1.2% to 0.9%. The Organisation for Economic Co-operation and Development (OECD) also revised it downward from 0.8% to 0.6%.

Of course, if the fiscal situation were sound, there would be no need to cut the budget like this. But France's spending surged sharply after experiencing COVID-19 since 2020. After the pandemic ended, the war between Russia and Ukraine broke out, and astronomical amounts of money were poured in to defend energy prices. France's expenditure ratio relative to GDP was 55.4% in 2019. However, it jumped sharply to 61.3% in 2020. Although spending was reduced in 2021 (59.1%) and 2022 (58.3%), it still remains higher than in the past.

The Revived EU Fiscal Rules... Risk of Credit Rating Downgrade if Not Met

It might seem reasonable to spend some money when the economy is struggling, but it is not that simple. The European Union (EU) has fiscal rules that must be followed. These were temporarily suspended due to COVID-19 but have been reactivated this year. According to the agreement, each country must set a spending plan that can reduce debt over four years. The debt-to-GDP ratio must be maintained below 60%, and the fiscal deficit relative to GDP must be within 3%. Countries that fail to meet these standards must reduce their excess debt annually. Countries with a debt ratio exceeding 90% of GDP must undertake intensive restructuring to reduce the debt ratio by 1 percentage point per year.

Experts view France's situation bleakly. Among the four major Eurozone economies (Germany, France, Italy, Spain), France is considered the country with the most difficult target achievement. Its fiscal deficit relative to GDP was about 4.9% last year, far exceeding the 3% standard. The French government must first reduce this to 4.4%, a 0.5 percentage point decrease. By 2027, it must meet 2.7%. The debt-to-GDP ratio also exceeded the standard at 111% in 2022. The plan is to reduce debt to 108% by 2027.

If the plan is not carried out as scheduled, the economy could worsen further. The country's credit rating could be downgraded. Reports continue that international credit rating agencies will downgrade France's debt rating. Fitch, an international credit rating agency, has already downgraded France's sovereign credit rating by one notch to 'AA-'. Standard & Poor's (S&P) has maintained the rating but plans to review it again in April this year. A downgrade in sovereign credit rating means that both the country and companies will find it harder to borrow money. Interest costs will naturally become more burdensome.

On the 18th local time, Bruno Le Maire, France's Minister of Finance, appeared on TF1, France's largest private TV channel. Photo by TF1 YouTube capture.

Whether for a country or an individual, there is no free lunch in the economy. If a large amount of money is spent, it must be compensated somewhere. If money is spent recklessly, the ensuing pain will be greater. However, France has firmly stated that it will not raise taxes to cover fiscal needs. Minister Le Maire said, “We will not deviate from the path of tax cuts. The French people cannot bear more taxes.”

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