If you think U.S. debt had a rough year, don’t look at France

For much of the past decade, borrowing money from France was considered as secure as lending to Germany. However, the situation has rapidly deteriorated. Last week, investors demanded up to 5% annually to lend to the French government for a decade, the highest level since before the 2011-2012 eurozone debt crisis. This premium over German borrowing costs highlights growing investor concerns about France's debt situation.

France's government debt has ballooned to 119% of GDP. The root cause is simple: the French state consistently spends more than it collects in taxes and borrows to bridge the gap. This year, the deficit is projected to reach 5.4% of GDP, the highest since records began. Government borrowing costs, which influence mortgage and business loan rates, now exceed those of Italy and Greece, two nations that were at the heart of the 2011-2012 crisis.

The French government's plan to address the deficit proposes about €54 billion in spending cuts and additional revenue. However, its track record of missing targets in recent years and the uncertainty surrounding the 2027 election have raised doubts. Investor confidence is faltering, with France's 10-year bond yield surging to 5%, surpassing Germany's equivalent bond. This widening gap signals investor unease about the sustainability of French debt.

The situation is further complicated by rising interest payments and defence spending, requiring the government to make deeper cuts than anticipated. Debt issuance in 2027 is expected to reach €340 billion, pushing the debt-to-GDP ratio to 121% and potentially stabilising at 124% by 2032. The political deadlock in Paris, with Prime Minister Sébastien Lecornu lacking a parliamentary majority, adds to the uncertainty. France may be forced to rely on emergency laws to finance essential government operations.

The crisis has spillover effects, with other European countries, such as Italy and Greece, experiencing widening spreads over German bonds. This suggests that the French debt crisis could spread beyond France. The European Central Bank (ECB) faces a challenging balancing act, as it tightens monetary policy to combat inflation but must also consider the impact of stressed government bond markets on the euro.

The immediate risk is political deadlock preventing France from passing its budget, potentially forcing the government to rely on emergency legislation to maintain essential financing. This would not provide a long-term solution but would keep the government operational. The long-term implications of France's sovereign debt crisis remain significant, with the potential for broader repercussions across the eurozone.