France: Higher Rates, Lower Growth to Weigh on Debt Dynamics Unless Reform Accelerates

The difficulty for President Emmanuel Macron is that enacting further growth-enhancing reforms requires particularly delicate and difficult manoeuvring – his government lacks a parliamentary majority – while the energy crisis is putting extra pressure on public finances and risks stoking social unrest through the winter.

In the meantime, the government’s announced financing requirement for 2023 of nearly EUR 300bn is among the highest on record. It will mainly be covered through the issuance of medium- and long-term borrowing of EUR 270bn net of buybacks, up from EUR 260bn in 2022.

France has consistently missed fiscal and debt targets in the past and looks as if it will do so again. Our baseline scenario, which assumes a less favourable interest-rate and macro-fiscal outlook (real growth of 1.5%; primary fiscal deficit of around 3% of GDP on average over 2022-27) will result in a moderate rise in public debt-to-GDP to 115.6% of GDP by 2027. In a less optimistic scenario, debt-to-GDP rises to more than 120%.

For now, the government projects a decline in public debt to 111.7% of GDP in 2025 and to 110.9% in 2027 as the headline deficit falls to below 3% of GDP by 2027, even though the sensitivity of the fiscal trajectory to higher interest rates has increased in recent decades as France added 77pp of GDP in public debt since the 1990s under what were improving financing conditions (Figure 1).

Figure 1: Trajectory of French yields has pivoted

French Government’s Baseline Fiscal, Economic Assumptions Look Optimistic

The government’s baseline assumptions remain optimistic: 10-year bond yields at 2.5% as of end-2022 (the highest since 2011) and at 2.6% as of end-2023, against 2.3% in early December 2022. The ECB has signalled interest rate increases to come, so the government’s less optimistic scenario in case rates exceed current projections by 200 basis points may prove more realistic: an interest-rate burden of EUR 94bn (or about 3.3% of GDP) in 2027 rather than a baseline forecast of EUR 61bn (2.1%), up from EUR 37.5bn (1.6%) in 2023.

The government projects a gradual decline of the fiscal deficit, to be potentially amended under the reform of the EU fiscal policy framework, but the pace of expenditure-based fiscal consolidation would be at risk if the withdrawal of measures to protect businesses and households from high energy prices is delayed as appears likely.

An antagonistic budgetary process, with the government relying on decrees rather than votes in parliament, underscores fragmented politics, increasing danger of fiscal slippage and only timid reforms. It also raises the risk of early elections should the parliamentary status quo resulting from June 2022 elections lead to legislative deadlock.

Pension Reform Remains Central Plank of Economic Policy

The Macron government is counting on reforms, principally those of France’s pension system, to improve growth potential (estimated at 1.35%) and reduce primary deficits. Any blockage will cast doubt over real growth projections of an increase from 1.0% in 2023 to 1.8% in 2027 despite the more difficult economic climate.

Weaker growth will inevitably work against the government meeting its debt-to-GDP objectives, further widening a divergence with the trajectory for the euro-area average (Figure 2), and justifying the concerns raised by the national fiscal council.

Figure 2. Public debt trajectory likely to exceed government’s projections (% GDP)

That said, we acknowledge the government’s pre-pandemic reforms have helped achieve a higher employment rate.

The government is deepening the 2021 reform of the unemployment benefit system and plans to revive the reform of the pension system in the first half of 2023, including increasing the retirement age to 65 in 2031.

As structural reforms can take years to bear effective results, a modest weakening in France’s medium-term debt trajectory would not necessarily lead to near-term risks for France’s AA credit ratings from Scope, provided we have sufficient comfort that the momentum behind structural reforms persists in the years ahead, and with that the expectation of significant medium- to long-term economic and fiscal dividends.

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Thomas Gillet is an Associate Director in Sovereign and Public Sector ratings at Scope Ratings GmbH. Thibault Vasse, Associate Director at Scope Ratings, contributed to writing this commentary.