The Unsustainable Burden of French Public Debt: Navigating High Interest Rates and Economic Challenges

France, in 2023, grapples with the daunting challenge of its burgeoning public debt, now compounded by rising interest rates. This financial predicament poses significant hurdles to the nation’s economic stability and necessitates a closer examination.

The Current State of French Public Debt

As of 2023, France’s public debt situation has become increasingly concerning, with the national debt reaching approximately €3 trillion. This figure represents around 112% of the country’s Gross Domestic Product (GDP), indicating that the amount owed surpasses the total value of goods and services produced by France in a year​​.

The surge in France’s debt levels can be attributed to a series of global crises, each necessitating substantial public spending. The COVID-19 pandemic, for instance, demanded significant government expenditure to support the economy and provide relief to affected citizens. Similarly, the energy and cost of living crises, triggered by geopolitical events like Russia’s invasion of Ukraine, further strained public finances as the government sought to mitigate the impacts on households and the broader economy​​.

Another factor contributing to the rising debt is the increasing cost of servicing this debt due to higher interest rates. The interest rate on France’s benchmark 10-year bond is anticipated to remain above 3% in the coming years. Consequently, the cost of servicing the debt is expected to exceed 70 billion euros by 2027, making it the largest item in the French state budget. These escalating interest costs underscore the challenge of managing such a high level of debt​​.

Despite these challenges, France has implemented measures to address its debt situation. The French government has emphasized the need for spending cuts as a primary tool for debt reduction. Plans include a directive for each ministry to reduce spending by 5%, with the aim of bringing the deficit below the European Union limit of 3% by 2027. However, these measures are based on optimistic forecasts of economic growth and inflation, which some other institutions have questioned. The French government maintains a growth forecast of 1% for 2023, even though organizations like the International Monetary Fund and the central bank have predicted lower growth rates​​.

Rising Interest Rates: A Growing Concern

The interest rate on France’s benchmark 10-year bond, a critical indicator of the nation’s borrowing costs, is projected to remain above 3% in the coming years. This elevated interest rate level is expected to significantly increase the cost of servicing France’s national debt. By 2027, it is anticipated that the cost of servicing the debt could exceed 70 billion euros, making it the largest item in the state’s budget.

This rise in interest rates and the consequent increase in debt servicing costs are largely a result of the European Central Bank’s (ECB) monetary policy adjustments. These adjustments have been implemented in response to inflationary pressures across the Eurozone. The ECB has been steadfast in its commitment to ensuring that inflation returns to its 2% medium-term target. To achieve this, the ECB decided to raise the three key interest rates by 25 basis points in June 2023. The rate increase reflects the ECB’s assessment of the inflation outlook, the dynamics of underlying inflation, and the strength of monetary policy transmission. The ECB’s future decisions are geared towards ensuring that these key interest rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to the 2% medium-term target and will be kept at those levels for as long as necessary.

Moreover, the ECB intends to reduce the Pandemic Emergency Purchase Programme (PEPP) portfolio over the second half of 2024 and discontinue its reinvestments under the PEPP at the end of 2024. This move forms part of the ECB’s broader strategy to normalize its balance sheet, which also impacts interest rates and, consequently, the cost of servicing public debt like that of France.

The tight monetary policy of the ECB is a reaction to persistent inflation, which, although showing signs of easing, is still projected to remain relatively high. The ECB’s decisions on interest rates are based on its assessment of the inflation outlook, considering the economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission.

These developments underscore the intricate relationship between ECB’s monetary policy decisions, inflationary trends, and national debt management strategies, as exemplified by France’s current economic situation.

Government’s Fiscal Strategy

One of the key focuses of the government’s plan is to end the exceptional crisis spending that had increased due to various global and domestic challenges. The savings generated from these cutbacks are intended to finance initiatives such as the green transition. This transition is crucial for France as it seeks to address environmental concerns while managing its fiscal responsibilities.

However, the government’s projections have faced criticism for their optimistic assumptions about economic growth and inflation rates. In response to these concerns, the Finance Minister Bruno Le Maire has been proactive in asking each ministry to identify areas where budget reductions can be made, especially in sectors like employment and housing policies.

It’s noteworthy that these spending cuts are occurring in a context where excessive spending has become a pressing issue, particularly as borrowing costs have risen significantly due to the global trend of interest rate hikes in the fight against inflation. The government’s debt reduction strategy will therefore be crucial in managing these increased costs and maintaining fiscal stability.

The Organisation for Economic Co-operation and Development (OECD) has also weighed in on France’s economic outlook. They project that GDP growth will ease before picking up again, with exports recovering owing to moderate improvements in external demand. However, they caution that less favorable financing conditions due to tighter monetary policy will continue to weigh on investment and consumption. Despite announced spending cuts, the budget deficit is expected to remain large, at 4.6% of GDP in 2025, indicating the need for ongoing fiscal consolidation efforts.

The Need for Structural Reforms

In response to the challenges of its high public debt, the French government has been urged to accelerate structural reforms, particularly targeting its pension system, to meet its debt-reduction goals. This task is complex due to the politically fragmented landscape and is further complicated by the ongoing energy crisis.

One of the central elements of these reforms is the overhaul of the French pension system. In 2023, significant changes were made to this system, most notably the controversial decision to raise the retirement age. The law, passed in April 2023, incrementally raises the retirement age from 62 to 64 by 2030, with a requirement that retirees have worked at least 43 years to receive a full pension. This reform is intended to bolster the country’s growth potential and reduce primary deficits by extending the working life of the population and addressing the pension system’s sustainability.

The reform process faced substantial opposition, both from the public and within parliament. The government employed a special constitutional procedure (Article 49–3 of the French Constitution) to pass the law without a direct vote in the National Assembly due to fears that it would not have enough support. This move led to motions of no confidence, which were eventually voted down, allowing the reform to pass. The Constitutional Council later affirmed the constitutionality of the law and rejected requests for a referendum.

The pension reform also includes several technical mechanisms to improve the recognition of arduous jobs, promote the transition from work to retirement, and increase the lowest pensions. However, the reform has been met with widespread criticism and protests, with many seeing it as a harsh and unfair measure. Opponents have argued that there are other ways to finance pensions than raising the retirement age.

This reform is a part of President Emmanuel Macron’s broader agenda to transform the French economy. However, the changes have led to significant political debate and social unrest, highlighting the challenges of implementing structural reforms in France’s complex political and social landscape.

International Perception and Ratings

Despite facing significant fiscal challenges, France has managed to retain its credibility in international financial markets, primarily due to its political stability and a consistent track record of honoring debt obligations. This reputation continues to make France an attractive destination for investors.

The French financial system, as assessed in December 2023 by the Banque de France, has navigated the high-interest-rate environment effectively. While this environment represents a shift for financial participants, the adjustments to monetary policy and the subsequent responses have been orderly. The euro area policy rates, after rapid adjustments that began in July 2022, seemed to have reached a plateau by September 2023, as core components of inflation showed signs of easing. However, these expectations are contingent on the absence of further economic or geopolitical shocks. French banks and insurers have shown resilience with solid balance sheets, allowing them to cope with risks and continue financing the economy. However, there remains a risk of financial instability due to potential macroeconomic or geopolitical shocks, particularly for non-bank financial intermediaries and heavily leveraged participants in the real economy.

In terms of economic performance, France’s finance minister, Bruno Le Maire, has projected a growth rate of 1.4% for 2024, slightly down from the earlier forecast of 1.6% but still better than the 1% expected for 2023. Inflation in France is expected to decrease from 4.9% to 2.6% by 2024, nearing the European Central Bank’s target. This reduction in inflation should bolster household consumption, traditionally a key driver of French economic growth. In line with these projections, the French government has planned fiscal measures, including spending cuts and environmentally friendly investments, to strengthen the economy and achieve fiscal consolidation.

Conclusion

France’s journey to stabilize and reduce its public debt is fraught with complexities. The government’s strategy needs to balance fiscal consolidation, structural reforms, and the management of external economic factors. While the path ahead is challenging, the nation’s continued efforts to address these issues are crucial for its long-term economic stability and growth.