French budget focuses on tax increases as analysts warn of rating downgrades

France’s newly installed government on Thursday presented a draft budget containing 60 billion euros ($65.6 billion) in tax increases and spending cuts, as analysts warned the package may not be enough to avoid rating downgrades. of the economy.

The 2025 budget focuses more on tax-increase measures than some expected. Analysts also pointed to “politically complicated” proposals, such as a delay in adjusting pensions for inflation and cuts to local governments, public administration and the health system.

Other key elements include temporary additional taxes on large companies and shipping corporations with revenues of more than €1 billion a year, affecting around 440 companies; a surcharge on income tax for households with incomes exceeding 500,000 euros; the reintroduction of a tax on electricity consumption; and an increase in taxes and fees on airline tickets and high-emission cars.

One of the main goals of the budget is to reduce France’s projected deficit from 6.1% in 2024 to 5% of gross domestic product next year, an effort to comply with European Union rules that state that the budget deficit of a member country must not exceed 3% of GDP.

The government set a new target of meeting this rule by 2029, an extension of its previous target of 2027. It also warned that the deficit could rise to 7% next year if no action is taken.

The task of finding 60 billion euros in one year left the government with few options, meaning it had to turn to those that are “politically complicated,” Hadrien Camatte, senior economist for France, Belgium and the region, told CNBC. Natixis euro. Squawk Box Europe” on Friday.

The fragile French government led by Prime Minister Michel Barnier has already faced a vote of no confidence this week, which it survived.

The government was formed last month after tense negotiations following July’s parliamentary elections, which handed the largest number of seats to the leftist New Popular Front (itself a relatively divided alliance), but failed to win any party or coalition a most.

Recognizing this, Barnier characterized the draft budget as a starting point to be debated by lawmakers and said he was open to changes that maintain its fiscal integrity.

“There will be changes and there will be a heated debate on pensions and social security contributions,” Camatte said, with debate on the budget starting on October 21 and votes on various parts of it starting on October 29.

“The problem is that when you have to find 60 billion, we have never found 60 billion in a year, it would be something unprecedented, and that is why it is not very credible to find such a huge amount, especially with only a very fragile relative majority. “

The policy mix underpinning the 2025 budget is “less biased toward spending cuts and more geared toward tax increases than we anticipated,” Goldman Sachs analysts said in a note Friday.

“The magnitude of the proposed consolidation and the corresponding reliance on tax increases leave us less confident in the government’s ability to meet its 5.0% deficit target by 2025. Our previous research has found that abrupt adjustments and Tax-based consolidations tend to be less likely to succeed in improving the fiscal position in a sustainable way,” they wrote, noting that their own deficit forecast was 5.2%.

However, they also noted the potential for some short-term political stability, given the government’s survival of the October 8 no-confidence vote.

This means their base case currently is for the government to pass the budget bill by the end of the year, they said, but with greater uncertainty beyond that point.

“When you need fresh money very quickly, you have no choice but to raise taxes. The problem is that taxes are already very high in France,” Natixis’ Camatte told CNBC, noting that the country has the second-highest wage tax. rate in Europe.

Despite the emphasis on tax increases, the split bill should see government spending cut by €40 billion, while revenues would increase by €20 billion, according to Erik-Jan van Harn, senior macroeconomic strategist. from Rabobank.

However, he added: “Barnier’s ambitious plans are fraught with implementation risks. His government is committed until 2029, but is unlikely to survive until then.”

Questions remain over what the 2025 budget will mean for France’s economic growth and whether the country can avoid further credit downgrades on its sovereign debt, following cuts by agencies S&P and Fitch over the past two years.

The government has extended its measures to try to avoid damaging economic growth, Evelyn Herrmann, European economist at Bank of America Global Research, told CNBC’s “Squawk Box Europe” on Friday.

“There is hope that by doing that and by perhaps targeting higher income groups and particularly profitable businesses more – and promising to do so temporarily – perhaps you will avoid a kind of strong effect typical of these measures on growth.” “. she continued.

However, Goldman Sachs analysts estimate that the package’s impact on economic growth will go from a 0.3 percentage point increase in 2024 to a 0.5 percentage point drag in 2025 and 2026; while UBS said the historically large fiscal consolidation of 2% of GDP would “likely hurt growth.”

Statistics agency Insee this week forecast 1.1% growth for the French economy this year, which Natixis’ Camatte described as “perhaps too optimistic, although not unrealistic.”

“My concern is about the trajectory beyond 2025, because the measures to reduce the deficit beyond 2025 are not documented and when you do a debt sustainability analysis, France’s trajectory is clearly a risk,” he said.

In the short term, ratings agencies would be in wait-and-see mode, given the lack of specific details on the budget, he added, although a negative outlook from S&P or Fitch cannot be ruled out.

“Right now it’s more important to stay calm and decide next year to see if the spending cuts are credible or not,” Camatte said. However, he expects agency Moody’s, which has maintained an improved rating for France, to go into a negative outlook this year before downgrading it next year.

Rabobank’s Van Harn was even more pessimistic, arguing that sharp spending cuts would “put a cap on economic growth” and that “a rating downgrade by one of the major ratings agencies appears likely.”

“Strict austerity has its price. Already weak economic growth will be hampered by a sharp turn in France’s fiscal stance. The government would do well to consider the economic side effects of its policy, but a lack of capital political party runs the risk that Barnier will be forced to make wrong decisions,” he said on Friday.

“Taking into account the risks already highlighted by [Fitch] and the comparatively optimistic nature of its previous projections, we consider a rating downgrade likely. While this is clearly not a positive from a spread perspective, we believe the market is already heavily pricing in such a move.”

— CNBC’s Charlotte Reed contributed to this story.