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Deficit spiraling out of control: French government plans drastic austerity program

Deficit spiraling out of control: French government plans drastic austerity program
Deficit spiraling out of control: French government plans drastic austerity program
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In an attempt to combat the high national debt, France’s new centre-right government under Prime Minister Michel Barnier has annoucned a drastic austerity programme shortly after taking office, planning to raise EUR 60bn through savings and additional revenues in 2025.

Two-thirds of this is to be achieved through spending cuts, and one third through tax increases aimed primarily at companies with high revenue, but also at high-income households. The goal is to limit the increasingly large budget deficit, which could reach around 6 per cent of the GDP this year, to 5 per cent.

National debt is “the real sword of Damocles” threatening France, said the new French Prime Minister Michel Barnier in his government statement in early October. The previous government had originally assumed a budget deficit of 5.1 per cent for 2024. This figure was amended to a 5.6 per cent deficit in early September, and in late September, the new budget minister Laurent Saint-Martin warned of an impending deficit of 6 per cent in Parliament’s budget committee. The renowned business newspaper Les Échos also reported on a possible deficit of this magnitude.

Lower income and excessive spending

The main reasons for the increase in the deficit are lower than expected tax revenues and excessive public spending. In addition, the protracted and difficult process of forming a government following the early elections four months ago is likely to have led to a wait-and-see attitude on the part of many economic players.

With this deficit, France exceeds the EU convergence criteria, which stipulate a maximum debt of 3 per cent of GDP for participation in the Economic and Monetary Union. The EU has therefore already initiated an excessive deficit procedure against the EU’s second-largest economy. The deadline originally set for the end of September for submission of a debt reduction plan has now been postponed to the end of October.

Turning away from business-friendly policies met with resistance

With their drastic spending cuts and tax increases, the plans now presented are a clear departure from the business-friendly policies of the previous government. In view of the financial situation, it was necessary “to demand a contribution from large companies that make high profits”, said Barnier.

The austerity budget has so far met with resistance in Parliament. Even before it was presented, there was criticism from both the left-wing camp and the right-wing nationalists. As the new government does not possess a majority in the National Assembly, it could therefore only get the budget through in a modified form or push its version past the MPs with a special article of the constitution.

There are also reservations in the ranks of the government, whose members are dissatisfied with the budget cuts and the departure from the previous economic policy. During President Emmanuel Macron’s previous term in office, taxes for large companies were reduced. Finally, criticism also came from the High Council of Finance, which assessed the government’s plans for their sustainability and concluded that the underlying growth forecasts were too optimistic.

Deficit and tax plans are being closely monitored on the financial markets

Developments in France are being closely monitored on the financial markets. The high level of debt and the difficulties in forming a government already caused uncertainty, but now there are also concerns that the austerity budget could slow down economic development.

On balance, the French stock market index MSCI France has barely moved since the beginning of the year, lagging behind the significant gains of other stock exchanges’ indices. In addition to the economic policy factors, there concerns about China’s economy also exacerbate matters on the stock market, as some important listed companies in France are particularly dependent on demand from China.

Note: Past performance is not a reliable indicator of future performance. Source: LSEG Datastream

Development MSCI France

Investors on the bond markets were also cautious about French government bonds this year in view of the new elections and the increasing deficit. The risk premium of French bonds measured by the yield spread to comparable German securities has risen noticeably this year. The rating agency Fitch revised its credit rating outlook for France from “stable” to “negative” in October due to the uncertainties around the economic policy. By way of explanation, Fitch also cited the uncertainty about a minority government’s ability to even get the necessary economic programmes off the ground.

Note: Past performance is not a reliable indicator of future performance. Source: LSEG Datastream. The risk premium is the difference between the yields on 10-year French government bonds and 10-year German government bonds.

Risk premium on French government bonds

According to informed circles, President Macron had already asked for understanding for the budget problems and possible tax increases at a meeting with high-ranking US bankers preceding the presentation of the budget plans. At a meeting with 13 financiers in late September, former investment banker Macron asked them not to overreact to possible tax increases, the news agency Reuters reported, citing insiders. Macron assured the investors present that these would be targeted and temporary measures due to the weak European economy.

However, some recently published economic data from France came as a positive surprise. The country’s industrial production rose unexpectedly by 1.4 per cent in August. Inflation in France also declined more than expected thanks to more favourable energy prices and reached its lowest level in over three years at 1.4 per cent in Septemb

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