France’s political chaos casts a long shadow on economic growth

French lawmakers will hold a no-confidence vote on Prime Minister Michel Barnier’s fragile minority government on Wednesday, as economists warn that the political deadlock likely to ensue will come at a high economic cost.

Two of the so-called “motions of censure” presented by both the left-wing and far-right opposition parties will be debated and voted on starting at 4:00 p.m. local time. The administration is widely considered to be overthrown just three months after it was formed. If the government collapses, Barnier – who failed to find a compromise within the bitterly divided National Assembly to pass a 2025 budget bill aimed at reducing France’s sizeable deficit – will be forced to tender his resignation to President Emmanuel Macron.

From there uncertainty reigns. Macron will eventually need to name a new prime minister, having struggled to secure that appointment following snap summer elections that gave the left-wing coalition the most votes but gave no party a majority. Veteran minister Barnier had been seen as a technocratic compromise.

“Once Barnier resigns, Macron will likely ask him to continue as interim. The alternative option of formally reappointing Barnier seems unlikely given the manifest lack of a majority,” Carsten Nickel, Teneo’s deputy director of research, said in a note. on Tuesday.

This provisional status could last for months as new elections cannot be held until next year, while another possibility is that Macron’s resignation triggers presidential elections within 35 days, Nickel said.

He added that such a series of events would leave the budget bill unapproved, and that a last-minute deal would seem unlikely.

Therefore, the interim government is likely to introduce a special constitutional law that would “effectively renew the 2024 accounts without any of the previously planned spending cuts or tax increases, while empowering the government to continue collecting taxes,” he said. .

Amid the turmoil, French borrowing costs are rising while the euro has been caught in negative sentiment, exacerbated by dismal eurozone manufacturing data and concurrent political volatility in Germany.

“France faces the prospect of a growing fiscal deficit that will become more expensive to finance as its [government bond] “Yields are rising amid this uncertainty,” Maybank analysts said in a note on Wednesday.

For international investors, the situation in France seems “very bad,” Javier Díaz-Giménez, an economics professor at Spain’s IESE Business School, told CNBC by phone.

“Without a budget, they would actually default, not because they cannot pay the interest on their debt, but because they will not do so without a budget. Rating agencies are already warning: French 10-year bonds have a higher premium than That of Greece, which is crazy in terms of fundamentals,” he said. Greece had briefly lost its investment grade credit rating amid the euro zone debt crisis, which led to the nation’s sovereign default.

“But that’s because pension funds don’t care, they just want a guaranteed income stream without worrying about legal shenanigans. So they’ll get rid of [French bonds] and go elsewhere,” Díaz-Giménez said.

“Beyond economic growth and stability, this will send debt in an unsustainable direction in France.”

Economists had already cut their growth forecasts for France following the publication of the budget proposal in October, given its broad tax increases and public spending cuts.

Analysts at Dutch bank ING, who previously forecast French growth would slow from 1.1% in 2024 to 0.6% in 2025, said Tuesday that the fall of Barnier’s government “would be bad news for the French economy.” “.

They also predicted the approval of an interim budget reflecting the 2024 framework.

“Such a budget will not rectify the trajectory of public spending,” they said, ruling out Barnier’s goal of reducing the public deficit from 6% of GDP to 5% in 2025, which would mean that France would not make progress towards meeting the new objectives. of the European Union. tax rules.

“At a time when economic growth in France is slowing markedly, this is bad news. The public deficit will remain high, the debt will continue to grow and the next government – ​​whenever that may be – will have an even more difficult task to manage. put public finances “It’s true,” said ING analysts.

Gilles Moëc, chief economist at AXA group, noted in a note on Monday that “France can count on large reserves of domestic savings to replace international investors, and the flow of data from the euro zone helps to decouple European yields from Americans, but in the medium term, directing “Too much domestic savings to finance the government can be costly in terms of growth dynamics.”

“Consumer confidence has already declined and the savings rate could rise further, thwarting the rebound in consumption that the government is counting on to support tax revenues in 2025,” Moëc said.

While both countries are mired in political turmoil, the spread between France’s and Germany’s borrowing costs hit a new 12-year high this month.

However, Díaz-Giménez of IESE Business School said that in some respects the French outlook was more positive than that of the euro zone’s largest economy.

“In France, the economic outlook is quite bleak, but it will not be a disaster if the secondary risks can be avoided. The high fiscal deficit is difficult to solve and requires political harmony, but a way out could still be found, it only puts pressure on the politicians to do their job and solve the real problems, in this case fiscal sustainability,” he told CNBC.

“But in Germany the problem is growth. The German economy needs a big adaptation to a new environment without Russian gas and in which manufacturing cars in Europe seems like a really bad business plan. From an economic point of view, this is more difficult to solve than The French Problem.”