France’s public debt: Can Macron change course?

France's budget deficit for 2023 exceeded expectations, reaching 5.5% of GDP instead of the projected 4.9%. This equates to a gap of roughly EUR 20bn more than anticipated, further contributing to France's already substantial sovereign debt burden (110.6% of GDP in 23Q4), which is widely considered to be excessive.

President Macron acknowledges the severity of the situation. Since taking office in 2017, Macron has been determined to comply with the Sustainability and Growth Pact (SGP). Initially, his efforts showed promise, as France's budget deficit decreased significantly in 2018 and 2019, bringing it into compliance with the EU’s budget rules for the first time in over a decade. However, the pandemic and subsequent energy crisis abruptly halted Macron's progress, as they caused the deficit to soar. After a three-year suspension, the budget rules were reformed and reinstated this year, and France faces significant challenges in getting its finances back on track.

It is noteworthy, however, that other European countries faced similar crises and that France did not necessarily allocate more funds towards energy subsidies than other countries.[1] But most European countries do have a smaller deficit. Surprisingly, France's deficit in 2023 was even greater than it was in 2022, during the height of the crisis. This suggests more factors are at play than merely the aftermath of these crises.

According to Bruno Le Maire, France's Economy and Finance Minister, tax revenues for 2023 fell short by approximately EUR 21bn compared to the projected amount. Increased spending on unemployment benefits and local government expenditures further added to the deficit. Another significant contributor is the rise in interest payments on France's existing debt (see Figure 3). Consequently, both the primary deficit and interest payments were higher in 2023 compared to the previous year and were higher than expected.

[1] According to Bruegel’s estimate.

Is this an unfortunate coincidence, or is there an underlying issue at play? The elevated interest payments, as we will demonstrate later, appear to be more structural in nature and largely beyond the control of the French government – at least in the short term. We are also inclined to regard the primary deficit as a structural concern, though this certainly isn’t beyond the control of the government, and boils down to policy choices. Figure 4 shows that there is a strong correlation between economic growth and the primary balance in France. But even during the prosperous period of 2017 to 2019, when the French economy experienced an average annual growth rate of over 2%, France still recorded a primary deficit of 1% of GDP. Combined with our projections for interest rate payments (see figure 5) and GDP growth, France’s budget deficit is unlikely to drop below the maximum threshold of 3% of GDP (stipulated in the EU budget rules), in the coming years. Especially since the European Commission focusses on the structural primary balance. A significant different fiscal policy is thus required.

In order to align with the SGP guidelines and fulfill President Macron's objectives, the French government requires a collective awakening to address the pressing issue of reducing public spending. Earlier this year, Le Maire announced budget cuts totalling EUR 10bn. However, the way forward remains uncertain. The Ministry of Finance in France has revised its deficit projection for 2024, raising it from 4.4% to 5.1%. This would still require additional budget cuts in 2024, but there is no consensus on how to achieve this goal.

Le Maire dismisses the idea of increasing income taxes and instead contemplates further reductions in social benefits and local government budgets. Implementing such budget cuts is likely to face opposition and would require parliamentary approval. This presents a challenge, as Macron's coalition lacks a majority. In the past, the government has resorted to utilizing article 49.3, which allows a minister to bypass parliamentary approval. However, given Macron's current low popularity, using the article could trigger a vote of no confidence, which poses the risk of toppling his government. Considering the coalition's standing in the polls, this option appears unfavorable for Macron and his Renaissance party.

Despite the challenging circumstances, the French ministry remains committed to its objective of reducing the deficit to below 3% by 2027. However, we believe that achieving this target is highly unlikely.

We forecast that France will struggle to get the deficit below 3% in the coming years(see figures 5 and 6),[2] even with a somewhat optimistic projection for the primary balance and assuming no economic shocks.[3]. The projected progress made in the primary balance will be largely offset by the mounting interest costs, as the renewal of maturing bonds will occur at higher prevailing interest rates. These interest costs are projected to escalate significantly, reaching well above EUR 80bn in 2028, compared to EUR 50bn in 2023. As a result, we only anticipate a modest improvement in the budget deficit over the coming years, reaching 3.6% of GDP by 2028.

To bring the deficit below 3%, a primary balance nearing 0% would need to be achieved within a few years. However, with a current primary deficit of 3.3%, realizing this target would demand significant structural spending cuts or higher revenues amounting to approximately EUR 80bn. Considering the existing lack of consensus on how to cut a “mere” EUR 10bn, accomplishing such substantial reductions appears highly unlikely. Although lower interest rates or higher (nominal) growth could provide some relief, banking on a more favorable external environment is hardly a strategy. Furthermore, relying solely on economic growth "windfalls" to address the debt and deficit ratio would not be enough to achieve a sustainable downward trajectory. This approach would not align with the necessary structural improvements mandated by the EU budget rules. While boosting structural GDP growth is a permissible strategy and preferable to austerity, it is challenging to accomplish, particularly in the short term. It requires a strong dedication to reforms and investments, an area in which France has historically not excelled.

[2] Please see the appendix of this report for a detailed description of our forecasting methodology.

[3] We use projections from the IMF’s World Economic Outlook which seems to assume quite some discretionary policy measures.

A slap on the wrist

The updated regulations of the SGP, as outlined in this report, offer greater flexibility for countries whose deficit or debt ratio fails to improve at the required pace. Governments can potentially gain leniency if they convince the Commission that their breach of the rules is temporary and serves to foster sustainable growth or strategic investments. However, France's budget situation is unlikely to qualify for such leniency. The magnitude of the deficit is simply too substantial to be overlooked or condoned by the Commission. Consequently, an excessive deficit procedure will probably be initiated, perhaps even in the near future. Should this procedure be enacted, France would have to lower its budget deficit on a structural basis by 0.5 percentage point per year (roughly EUR 14bn in today’s prices) or pay a fine equivalent to 0.05% of GDP every six months until full compliance is achieved. In the transition phase running until 2027, the annual structural adjustment does not have to compensate for the increase in interest payments, alleviating some pressure. But still, without corrective measures from the French government, a slap on the wrist from Brussels appears inevitable.

France's public finances are marked by bad habits, and the recent rise in interest rates puts the government's commitment to improving the situation to the ultimate test. The pressing question is whether they have the willingness and capability to enhance their budget balance or if their efforts will face significant obstacles within parliament.

Considering the current political landscape and the rising interest costs, our outlook is rather pessimistic regarding Macron's ability to achieve his goals and compliance with the EU budget rules. The necessary spending reductions in the coming years would need to surpass the cuts that have been announced thus far by a significant margin. As the magnitude of required budget cuts increases over the years, the challenges associated with implementing them are likely to intensify too. Hence, the likelihood of a reprimand from Brussels increases, especially as the Commission appears determined to showcase the enforcement of the new SGP rules.