Fiscal Deficit to Persist Next Year... Highest in EU
Concerns Raised Over 'Second Liz Truss Crisis'
With the second round of the French legislative elections scheduled for the 7th, there are forecasts that whether the far-right Rassemblement National (RN) secures a majority of seats or not, both scenarios will negatively impact the French economy.
According to Bloomberg on the 3rd (local time), credit rating agency Scope Ratings assessed that France's existing plan to reduce its fiscal deficit to below the European Union (EU) threshold (3% of GDP) by 2027 has already expired, and no voting scenario is expected to improve this outlook.
According to the European Commission, France is expected to run a deficit equivalent to 5% of GDP next year. Although this is an improvement from the 5.3% recorded this year, it remains the highest level in the EU. Scope Ratings stated, "Whether the parliament falls into deadlock or RN achieves a complete victory, the prospects for reforms aimed at promoting growth and reducing costs will become uncertain, putting pressure on France's sovereign credit rating."
According to a poll released by Harris Interactive on the same day, RN is expected to win 190 to 220 seats in the second round, falling short of the majority of 289 seats. The left-wing coalition Nouvelle Union Populaire ?cologique et Sociale (NUPES) is projected to secure 159 to 183 seats, while President Emmanuel Macron's ruling party Renaissance and the broader pro-government coalition Ensemble are expected to win 110 to 135 seats.
Some express concerns that a 'second Liz Truss crisis' could occur in France as well. In 2022, former UK Prime Minister Liz Truss introduced a large-scale tax cut policy immediately after taking office, which caused a massive fiscal deficit and turmoil in financial markets, leading to her resignation. The Montaigne Institute think tank reported that if all parties' pledges are implemented, NUPES would incur an additional annual expenditure of 95 billion euros, RN 48 billion euros, and Ensemble 15 billion euros.
After President Macron decided to hold early elections last month, French government bond yields surged to their highest levels since the Southern European debt crisis in 2012. Although they have since eased, concerns remain that public spending will increase and debt will expand regardless of the outcome. Analysts note that France's tight public finances and high political polarization limit the government's policy flexibility, and that the election results are likely to exacerbate these risks. There are also forecasts of political deadlock or a retreat from market-friendly policies. Following the first round of voting, expectations that RN will either secure a majority or that a cohabitation government will be formed have already pushed borrowing costs higher. As of around 10:45 a.m. that day, the yield on French 10-year government bonds was hovering around 3.246%.
Currently, about half of French government bonds are held by foreign investors. Due to the political situation and increasing debt, there are concerns that France may lose its appeal to foreign investors. Analysts point out that while the high proportion of foreign investors broadens the investment base, it also makes it vulnerable to sudden shifts in sentiment. Thomas Vielledent, an economist at T. Rowe Price, said the market is particularly uneasy about the movements of Japanese investors, as a rate hike in Japan could reduce trading profitability.
There are also forecasts that no major market turmoil will occur in the short term. Holger Schmieding, chief European economist at Berenberg, said, "At present, the likelihood of a situation like Liz Truss's is low. We do not expect sudden turmoil in the French bond market," and predicted, "RN will take a relatively moderate stance on fiscal policy."
However, Schmieding expressed concerns about France's long-term fundamentals, especially if President Macron's pro-growth policy line is abandoned. France's public debt exceeded 115% of GDP in 2020, and last year the debt-to-GDP ratio was 111%, ranking third highest in the EU. In this situation, if growth slows, borrowing costs could rise or credit ratings could be further downgraded.
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