Why the sell-off in French bonds is a warning for global governments

The recent decline in French government bond prices signals that investors are growing wary of excessive borrowing and ongoing budget deficits, according to Capital Economics. Chief Global Economist Jennifer McKeown suggests that France's predicament may prompt other nations to speed up spending cuts and fiscal consolidation efforts.

However, the consultancy's economists believe a broader fiscal crisis in advanced economies is unlikely due to the rarity of countries with such weak public finances and limited political capacity to curb spending.

France's gross government debt is projected to reach 118% of GDP by 2026, slightly lower than Japan's, Italy's, and the U.S.'s levels, and comparable to the UK's. The International Monetary Fund projects France to maintain a primary budget deficit of 2.8% of GDP this year, higher than the UK's 1.4% deficit and Italy's 1% surplus. To stabilize its debt ratio, France would need to achieve a near-zero primary budget balance, necessitating significant fiscal adjustments.

The challenge lies in political constraints, with President Emmanuel Macron's government lacking a majority in the National Assembly and struggling to pass a budget. Proposed spending reductions have encountered resistance and protests. Investors are also worried about the potential for increased fiscal populism ahead of next year's presidential election, where Marine Le Pen is currently the frontrunner.

Capital Economics forecasts France's headline budget deficit to remain around 5.4% rather than experiencing a substantial decline.

Given that foreign investors hold about 60% of France's marketable sovereign debt, equivalent to approximately €1.6 trillion, a significant portion outside the euro zone, a sharp fall in bond prices could cause losses for banks, insurers, and investment funds, possibly reducing capital and leading to asset sales. However, the consultancy considers the risk of a systemic shock to be low due to the widespread distribution of these holdings.