With around half a year remaining before the next presidential election, France is in danger of becoming a stress test for the eurozone: a political crisis, a deteriorating fiscal position and growing market doubts about the country’s ability to finance its mounting debt burden are all converging. France faces a significant structural imbalance in its public finances. The budget deficit exceeds 5 per cent of GDP , while public expenditure stands at around 57 per cent of GDP. At the same time, public debt is rising steadily and could, without sufficient fiscal consolidation measures, exceed 130 per cent of GDP by 2030 . The interest burden on public debt is rising rapidly and could rise to more than 120 billion euros, equivalent to 3.5 per cent of GDP by 2030. The central challenge, however, may not lie in the fiscal arithmetic of the budget, but in the political capacity to address it. On the one hand, the costs of social welfare expenditure are no longer sustainable; on the other, the majority of the population continues to demand more state intervention. The situation is compounded by the lack of a parliamentary majority and limited prospects of achieving one in the near future. The global environment is also weighing heavily: Tensions involving Iran are driving up fuel prices and inflation, while US fiscal concerns are putting upward pressure on bond yields.
An election campaign lacking a commitment to fiscal consolidation
With just over six months to go before the first round of the presidential election, the French economic debate is dominated by promises of additional spending, including commitments to lower the retirement age, as well as by diversionary issues such as constitutional referendums and by nationalist and protectionist rhetoric often accompanied by strongly Eurosceptic undertones. Jean-Luc Mélenchon’s call for a partial write-off of French debt held by the Banque de France, a member of the Eurosystem, is adding to market concerns about France. Marine Le Pen’s proposals, too – such as maintaining the low retirement age or escalating conflicts with the EU (over Schengen, migration policy and the EU budget) – could increase pressure on French government bonds and further weaken the economy through capital outflows. The high and rising share of foreign investors in French public debt, which stands at 56 per cent , makes the country even more vulnerable to shifts in market sentiment.
This raises the crucial question: What happens if market pressure on France persists and there is no parliamentary majority in favour of fiscal consolidation? The eurozone has no legal or political mechanisms in place in the event that the political system of a key member state becomes paralysed. The only credible safety net remains the European Central Bank’s (ECB) bond-purchasing programme, the Transmission Protection Instrument (TPI). The problem, however, is that the Eurosystem cannot finance France’s deficit or purchase French government bonds at will, solely in response to rising yields. Should broader intervention become necessary in the absence of a credible fiscal consolidation path from Paris, the ECB Governing Council would face a legally and politically difficult decision. The ECB would then find itself caught in a conflict of objectives between its mandate to protect the stability of the eurozone and its duty to prevent the single monetary policy from replacing the French government’s fiscal policy.
The real test for the eurozone
The previous eurozone crisis was triggered by smaller economies on its periphery, yet it nearly caused the collapse of the monetary union. A growing loss of market confidence in France would be a far more severe test for the eurozone. Bond purchases can mitigate acute liquidity and refinancing risks, but they merely shift the problem into a chronic structural fiscal crisis, which, if it escalates further, could eventually overwhelm the capabilities of monetary policy. The real test for the eurozone will be whether it can maintain stability in the bond market in Europe’s second-largest economy without relieving it of responsibility for its own fiscal policy. Should this balancing act fail, the Eurosystem could, in the short term, use its instruments to limit acute market distortions in the bond markets. However, such measures cannot permanently cushion the consequences of an unsustainable fiscal trajectory. The longer the fiscal problems remain unresolved, the more they will exacerbate political tensions over the limits of European solidarity and the future of the monetary union, thereby undermining confidence in the European institutions and the cohesion of the EU.
Political Instability Meets Fiscal Limits: Is France the Euro’s Next Big Stress Test?
Aggregated summary from an independent source. Read the original at SWP-Berlin.