Risks and Vulnerabilities France: Will France Be the Next Victim of the Sovereign Debt Crisis?

Economic growth in France, the eurozone’s second largest economy, has stagnated since 2012. Our Risks and Vulnerabilities Country Briefing highlights that one of the biggest threats to the country’s macroeconomic stability is the public debt, which the IMF forecasts will hit record levels in 2014 of 95.8% of GDP. The government has committed to reducing its general government budget deficit to below 3.0% of GDP by 2015 (the EU-wide limit) from 4.3% in 2013.

Many analysts blame the increase in public debt on tax rises such as the VAT increase in 2014 and the effective 75.0% tax on salaries above €1 million (to be paid by companies after conditions were revised), arguing that these have resulted in even more subdued economic growth by weighing down on consumer and business confidence. Others blame the country’s high levels of social welfare spending. Government expenditure on social security and welfare in France accounted for 44.2% of government spending in 2013, amongst the highest in the OECD. Furthermore, the government faces repeated difficulty in carrying out reform or savings cuts because of social discontent and frequent strike action. Yet France is at risk of being the next victim of the eurozone sovereign debt crisis if the public debt continues to escalate, which will harm investor confidence and further damage economic growth prospects.

French Public Debt as a Percentage of GDP vs. Real GDP Growth: 2008-2013

Source: Euromonitor International from national statistics/Eurostat/International Monetary Fund (IMF), World Economic Outlook (WEO)/OECD/UN

French Public Debt Continues to Escalate

• Public debt levels continue to remain high, thereby limiting fiscal flexibility. Public debt amounted to €1.9 trillion (US$2.6 trillion) or 94.4% of total GDP in 2013, while, external debt amounted to US$5.5 trillion or 203% of total GDP in 2013, suggesting that fiscal and external sector sustainability remain at risk;
• Given fiscal and labour reforms, France’s sovereign credit rating of AA with stable outlook from ratings agency, Standard and Poor’s, has been affirmed in 2014. The commensurate rating from Moody’s stands at Aa1 with negative outlook in 2014. High debt levels continue to weigh on the country’s credit worthiness;
• With the government announcing social spending cuts of €50.0 billion during the 2014-2017 period, the strategy is now seen to shift towards the expenditure side. In 2013, France registered a general government budget deficit of €88.2 billion (US$117 billion) or 4.3% of total GDP, down from €99.4 billion (US$128 billion) or 4.9% of total GDP in 2012;
• In December 2013, the French government gained approval from the courts to heavily tax its super-rich. Companies paying out salaries greater than €1.0 million (US$1.4 million) are now liable to pay a 50.0% duty, which in combination with other social charges and taxes amounts to 75.0% of salaries above the threshold as tax; this would be effective on salaries paid out in 2013 and 2014. While this move is expected to boost the government exchequer by €210 million a year, it is a major disincentive for the labour market and entrepreneurs alike;
• Socio-economic protests have been persistent amidst continued economic downturn; rising unemployment; increase in tax rates; and unpopular European Union (EU)-imposed austerity measures, such as pension reforms; healthcare spending cuts; and reductions in unemployment benefits.

Macroeconomic Stability Threatened by Record Government Debt

The level of public debt in France is significant, not just for the country’s own macroeconomic stability, but for the entire eurozone should there be a resumption of concerns about unsustainable sovereign debt. This could have spill over effects across the economic bloc, especially as France is the eurozone’s second largest economy. There is currently a debate about how public debt is calculated as France thinks it should not include financial support made to struggling eurozone countries or the ailing banking sector. The IMF forecasts that French public debt will decline to 87.6% of GDP by 2019. Further economic stagnation and persistent high unemployment are risk factors for government debt overall as they contribute to below potential taxation levels. The government needs to push through necessary but unpopular economic reforms in order to kick-start economic growth which will help to bring down the debt burden and subsequently restore confidence in the French economy. Dissatisfaction with the government was made clear by the unprecedented win of the National Front far right party in the European Parliament elections in May 2014.