French budget crisis show fiscal fears are rising back up the agenda
The mounting budget crisis in France looks set to revive the spectre of sovereign debt levels playing an increasingly large role in shaping market movements – and the political fallout.
For a while investors have been airily issuing warnings about elevated levels of national debt. Now, with the French government on the verge of collapse, there is an event on which they can pin their warnings.
It is no surprise that Michel Barnier’s government is in danger of falling. Essentially, Barnier was tasked with an impossible job: force an unpopular budget through the National Assembly, even though he lacked a parliamentary majority.
Barnier’s budget would have seen €40bn of spending cuts and €20bn in tax increases, which he argued was necessary to address the parlous state of the public finances. French government debt stands at around 110 per cent of GDP, while the budget deficit is set to rise to seven per cent next year.
It looks like Barnier will fail. The Prime Minister has used a constitutional trick to try and force his budget through without a parliamentary vote, but this has left him open to a vote of no-confidence which could be held as soon as Wednesday. He will almost certainly lose.
Barnier warned there would be a “big storm” if markets did not accept his budget and it looks as if the storm clouds of angry bond markets might already be gathering.
The spread between the benchmark 10-year French bond and the German equivalent rose to a 12-year high last week, suggesting investors want a higher premium to hold French debt.
Ce n’est pas bien.
Who knows what will happen next. What is clear is that this issue is not going anywhere, in France or in any other advanced economy.
In last week’s financial stability report, the Bank of England issued yet another warning about elevated levels of government debt across rich economies.
“A deterioration in market perceptions about the sustainability of the long-term path of public debt globally may lead to higher rates, increased term premia and market volatility,” Bank officials wrote.
Market jitters due to high public debt will only get more prevalent over the coming years. Recent projections from the International Monetary Fund (IMF) suggest that global public debt will approach 100 per cent of GDP by 2030, largely driven by the US and China.
Indeed, at first glance the US situation looks even worse than France: National debt stands at 123 per cent while the deficit will likely balloon under a second Trump presidency – despite Elon Musk’s plans to cut federal spending.
The US can run such a seemingly unsustainable fiscal policy because of the privileges afforded by the dollar. But still, you would think something has to give sooner or later.
In the UK, meanwhile, government debt hovers around 100 per cent of GDP. Forecasts from the Office for Budget Responsibility suggest this will increase to 270 per cent of GDP by the 2070s.
It is hardly a fringe opinion to suggest that markets will demand some action on government debt sooner or later, but exactly what form this ‘action’ should take is another question entirely.
Without addressing it directly, there are a few important points to bear in mind.
The first point is that the really important issue is market perception of national debt, rather than the level of debt in itself (although there’s clearly a link between the two).
The level of national debt does not necessarily signify anything (just look at Japan with debt around 260 per cent of GDP). Market perceptions, on the other hand, really do matter, as demonstrated by Liz Truss’s laughably short tenure as Prime Minister.
The second point – only worth noting rather than stressing – is just how difficult it is for modern democracies to raise taxes or cut spending on the sort of scale required to stop debt rising inexorably.
The final point – and this one is definitely worth stressing – is that stronger economic growth could make a massive difference.
On the OBR’s estimates, if productivity growth were to return to its pre-financial crisis levels in the UK – and the government used the proceeds to pay down debt – that would keep debt below 100 per cent of GDP for the next 50 years.
In other words, sustainable growth essentially guarantees debt sustainability. Unfortunately, France appears to have missed the boat on that one.