Financial Insights That Matter
The new French budget was finally approved in the first week of February. The question now is whether it will deliver on its promises.
In a nutshell
- France’s public deficit exceeded 6 percent of GDP in 2024, violating EU rules
- The new government budget was adopted in early February after months of uncertainty
- Political instability has threatened economic growth and fiscal reform efforts
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All of Europe is closely watching France, the eurozone’s second-largest economy. The mix of political instability and financial issues in the ‘Grande Nation’ is concerning. France’s public debt last year reached an estimated 112 percent of its gross domestic product (GDP), accounting for one-fourth of total European Union public debt. In July 2024, the EU took formal action against France for violating the bloc’s budgetary rules. Every EU member is expected to keep its public deficit below 3 percent, but France’s deficit rose to 6.1 percent in 2024, up from the already high level of 5.5 percent in 2023.
Since the last parliamentary elections in June, French President Emmanuel Macron has struggled to establish a stable government, which is critical as reforms become increasingly urgent in a country with nearly 57 percent of public spending in GDP in 2024. Although a new government was formed before Christmas, it has faced numerous political and economic challenges in finalizing its budget, while a temporary law continues with the 2024 spending framework. The government budget was adopted only in the first week of February.
Facts & figures
The French government’s budget deficit
The current political landscape in France
The current government of Prime Minister Francois Bayrou faced the first challenge of building consensus around its proposed budget. This was crucial to avoid being ousted by a no-confidence vote in the National Assembly before the spending package was adopted. This scenario now appears to be gradually receding after two unsuccessful no-confidence votes and the agreement on the government budget.
For the past 60 years, the French Republic operated under the structure of rationalized parliamentarism, where the government was supported by the National Assembly or even the entire parliament. Today, following Mr. Macron’s dissolution of the National Assembly in June 2024, the situation has changed. The Assembly is currently divided into three main factions – the left, the right and the Macronist center. Consequently, support for the government is no longer guaranteed. Without a majority, the government must form coalitions to pass its budget. It has initiated extensive discussions with all parliamentary groups to address this challenge.
While it took nearly three months to appoint former Prime Minister Michel Barnier in early September, his government lasted only 99 days. The left and right parties in the National Assembly initiated a successful no-confidence vote after Mr. Barnier invoked a special constitutional provision, known as Article 49.3, to curtail debates on the social security budget and so the broader budget could be approved. Creating a large coalition in such a polarized and fragmented parliamentary landscape is new for France, where politicians are not used to such practices.
New compromises
Prime Minister Bayrou’s strategy to survive no-confidence votes – his government faced and survived such a parliamentary vote in mid-January and early February − hinged on reaching out to the center-left, in contrast to Mr. Barnier’s approach of courting the far right (although the new prime minister sparked outrage after he recently said that immigration could cause a “feeling of submersion”). A key first step in this direction was his appointment of Eric Lombard, a “banker from the left,” as economy minister. Mr. Bayrou chose a “less austere” budget compared to the previous government’s proposals, implementing about 50 plus billion euros in austerity measures instead of 60 billion euros. The new plan initially included 32 billion euros in fiscal cuts alongside 21 billion euros in anticipated new fiscal revenues.
At the same time, the government aimed to reassure those on the right by stating that there would be no new or increased taxes that could hurt the purchasing power of the middle class. It also emphasized that public spending must be efficient, invoking the use of the numerous reports generated by the National Audit Office and the parliament to identify areas for savings. The fact that such a straightforward and obvious approach was presented as an innovation underscores the significant “mental” shift needed for genuine reform in the country. During his speech to the National Assembly on January 14, Prime Minister Bayrou stressed the importance of protecting French companies from exponential increases in taxes. He emphasized the duty of lawmakers to approve France’s budget, even if it is not perfect, to end the ongoing uncertainty.
Economic pressures and budget challenges
In addition to political hurdles, the budget has been an impossible headache because of economic factors. The original forecast for the country’s overall economic growth in 2024 was 1.1 percent, but the newly appointed economy minister has lowered that estimate to 0.8 percent. This adjustment is partly due to a recession in Germany, France’s primary economic partner. As a result, a decline in tax revenues is likely, which will lead to a larger deficit.
When economic growth is sluggish, governments often consider expansionary fiscal policies. Yet, faced with the current financial turmoil, these measures, of course, remain elusive for the French government despite their popularity among the left. Last summer, experts from the economy ministry suggested cutting a cumulative 110 billion euros over the next three years. The current administration has also indicated plans for spending reductions the next five years.
Public spending remains at a historically high level. In 2024, it accounted for approximately 57 percent of the country’s GDP, making it one of the highest rates in the world. Of course, given France’s financial situation, action must be taken. However, more austerity through significant public spending cuts could trigger a decline in economic activity in the short term. Two major consequences would then loom large: social discontent with political repercussions, reminiscent of the Yellow Vests episode (along with an additional negative effect on growth), and a decline in tax revenues that would exacerbate the deficit in the short term.
While it is theoretically both possible and desirable to reduce public spending by targeting inefficiencies and wasteful subsidies without creating injustice, such steps would require meaningful democratic debate, which appears out of reach in current conditions. Even so, incomes would still be affected during this adjustment. To compensate for these changes and promote growth, the private sector would have to step up to create value and jobs. Yet this depends on business confidence and market flexibility – two elements that France currently lacks.
Read more from Emmanuel Martin
One aspect of public spending that requires attention are pensions, which cost about 70 billion euros more each year than the social contributions received to cover them. This situation led Mr. Macron to implement the pension reform in 2023. Both the left and the far right have pushed to repeal the changes, which would have two consequences. First, there would be a greater budgetary gap, and second, a shrinking workforce would hinder economic growth. Consequently, both would negatively affect public finances.
On the revenue side, just like under the previous government, the issue of tax justice has been raised to justify increasing taxes on wealthy households (by introducing a special “differential contribution of high incomes” in the French finance bill for 2025) and big companies, all intending to protect the middle class and the poor. The tax on air tickets would be tripled, which prompted low-cost airline Ryanair to threaten cuts to many of its destinations in France if the government went ahead with this proposal.
There was also a strong focus on combating excessive tax optimization (the loose definition of which certainly creates more legal uncertainty) and measures to tackle tax fraud.
Under certain conditions, a tax cut could boost economic activity in the medium term (the well-known Laffer effect), particularly considering France’s high tax burden, which is around 46 percent of GDP. However, it would risk increase the deficit in the short term. So, for now, this option has been ruled out.
Costly implications of political instability
The underlying problem is that France’s current political instability has exacerbated an already urgent situation, which is detrimental to the economy. It has created uncertainty, causing households to delay important purchases and save for precautionary reasons, which leads to a decline in consumption. Part of last year’s expected deficit is attributed to a drop in value-added tax (VAT) due to weak consumption. As a result, given weaker earnings, businesses were reluctant to hire and invest, particularly since future taxation was uncertain. In this environment, with the potential for increased defaults, banks were hesitant to lend, further deepening economic gloom. France’s benchmark stock market index, the CAC 40, has lagged behind other European indices, dropping 2.1 percent over the past year, while even the DAX in struggling Germany rose by 15 percent in 2024.
The latest data for the last quarter shows that GDP growth shrank 0.1 percent, alongside a notable 3.9 percent rise in category A unemployment (these are unemployed individuals who must engage in proactive job searching), the largest increase seen in a decade. Additionally, in 2024, business bankruptcies surged by 18 percent.
Facts & figures
France-Germany 10-year government bond spread
Questions of financial hydraulics must also confront two other crucial constraints: Brussels and international investors. France has one of the highest public spending rates in the world and a staggering public debt – only Greece and Italy are faring worse. Deficits have accumulated since 1974, and France has upheld terms of the European Stability and Growth Pact only three times since the euro’s introduction in 2002. The European Commission launched an excessive deficit procedure against France in July. The government delayed restoring the 3 percent deficit target from 2027 to 2029.
The perceived inability to agree on a budget during such a dire time has understandably shaken the confidence of sovereign bond investors. Since the National Assembly was dissolved following the European election results, France’s borrowing cost has experienced heightened tensions, reaching 3.47 percent on the 10-year bond on January 14. The gap between French and German bond yields had widened to 90 basis points in November, the highest level since the EU debt crisis 12 years ago. This is particularly concerning when even Germany, once a reliable benchmark, grapples with its own quasi-recession and serious structural industrial challenges. In fact, for the first time in history, France’s benchmark bond yield has matched that of Greece. Rating agencies have intensified their scrutiny, with S&P and Fitch adopting a negative outlook, while Moody’s surprised many by downgrading France on December 13.
Between the lines
After this painful delivery, will the budget actually deliver? Recent data indicates that there will not be any real net spending cuts. The High Council on Public Spending acknowledged at the end of January that public expenditure is set to rise to 56.7 percent of GDP, which translates to a real increase of 0.8 percent or an additional 41.5 billion euros. Their report highlights that “excluding exceptional expenses and debt interests, the spending increase in volume would be 0.8 percent, vs. +2.4 in 2024.” Instead of implementing actual spending cuts, there will be a slowdown in the increase of expenditures. This indicates that the austerity measures are not fundamentally structural; rather, they involve cuts made in a piecemeal fashion, “here and there.”
Facts & figures
Economic amateurism
From “golden rules” to the current budget, France’s response to rising deficits has consistently been to raise taxes, never to implement structural reforms in public spending. It appears to be a reflex. For instance, on the day after the budget was finally adopted, micro-entrepreneurs criticized an unexpected measure that lowered the threshold for the obligation to process VAT from 37,500 euros in turnover to 25,000 euros. This would not only create the burden of managing accounting costs, but it would also force either a price hike for customers or a reduction in profits for the business. The inevitable result of this situation is that under-reporting would become a common practice. Many were left puzzled about the rationale behind this initiative. The next day, Prime Minister Bayrou was forced to backtrack, admitting he had no prior knowledge of the measure included in his own budget. Astonishingly, none of the 132,000 employees in the Ministry of the Economy had brought up this absurd proposal. It may not come as a surprise that the Minister of the Economy has stated that, in the context of the green transition, businesses will need to be prepared to accept reduced profitability.
As a result of the lack of structural reforms, the upcoming tax increases are quite significant. Companies with a turnover exceeding 3 billion euros will face a rise in corporate tax from the current rate of 25 percent to 35 percent. This comes at a time when many countries in the EU and around the globe are actually lowering their corporate tax rates. This change particularly ruffled the feathers of Bernard Arnault, the billionaire head of LVMH. Moreover, France continues to impose excessively high production taxes (on means of production rather than on turnover or profits), which stifles growth and jobs and urgently need reform. To make matters worse, the budget was adopted with a VAT measure that significantly impacts micro-companies (see box). So much for “reindustrialization” efforts (as we predicted).
Scenarios
Despite the long-awaited adoption of the government budget, the government is still constrained politically (and could well be overthrown by new laws) and economically, making an optimistic future about its finances difficult to envision. Moreover, as of January 1, the European Central Bank (ECB) has ceased repurchasing all sovereign debt, effectively ending its safety net and the negative moral hazard it created. This leaves France under even greater pressure at the worst possible time.
Most likely: The band-aid approach keeps France afloat in the short term
There is a sense of relief in finally seeing a French budget, especially considering the potential systemic risks France might pose in the event of serious financial issues. As a result, rating agencies and the EU will likely choose to exercise a degree of measured leniency. The ECB lowered interest rates on January 30, which will have an indirect favorable effect for French interest payments. The “papering over the cracks” strategy might still work this year, although it will likely become untenable over the next four or five years. A significant portion of the population appears to recognize that simply taxing businesses and raising taxes is not the answer, although taxing the rich remains a popular option. Many are also realizing that it is necessary to scale back social benefits and reduce the number of civil servants. This shift in perspective opens up opportunities for political change and structural reforms within this year’s democratic debates.
Not unlikely: France’s economy could weaken further
Rating agencies will not accept superficial fixes. France’s credit rating is precariously close to falling below the AA rating, and a new downgrade would remove it from the AA club. This would effectively limit the country’s ability to attract investors and lead to higher borrowing costs. Given the potential risks for the entire European bloc, Brussels would exert maximum pressure. This situation could force the imposition of a technocratic government that would implement strict austerity measures in France. Unsurprisingly, this would certainly provoke violent protests. The only glimmer of hope may be that a significant crisis could awaken the French people to the necessity of genuine democracy, which is essential for stronger public finances. The upcoming rating updates (February 28 for Standard & Poor’s) will reveal more.
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