France suffers from public debt

BarcelonaFrance is once again in the eyes of the world the sick man of Europe. It is nothing new in a country historically marked by labor conflict, political scandals, military defeats, and crises of all kinds, but at the same time, it is not good news that, in the current climate of student protests and a pre-election environment marked by the rise of the far-right, fears for the viability of the country's public finances are now being added.

In October of a year ago, a ten-year French bond paid an interest rate of 2.9%. Today it pays 4.8%. This increase in the cost of debt is the markets' response to a situation of public finances that seems, at least on paper, complicated to sustain in the long term.

France is the third most indebted country in the eurozone. The total volume of its debt is 117% of its gross domestic product (GDP, the indicator that measures the size of an economy), a figure surpassed only by Greece and Italy. And since the creation of the euro in 1999, the government has always had a deficit; that is, every year it has spent more than it has earned. Of all these fiscal years, in only three has the deficit been lower than 3% of GDP, the maximum figure set by European Union treaties.

The problem, however, is not just one of figures, but of the causes of this debt. The French state "has very high rigid expenditure," concentrated largely in "programs that are very difficult to cut from one day to the next," such as pensions, public salaries, or healthcare spending, explains Joan Ribas, an economics professor at Pompeu Fabra University. In fact, government spending reaches the equivalent of 56% of GDP, a figure much higher than most developed economies. It must be added, in this regard, that the strong "political fragmentation" hinders the possibility of major state pacts to reform certain public programs and, even if they were reached, "the risk of non-execution" of these agreements would remain high as a result of the great variety of parties with opposing ideologies.

This high indebtedness, added to the evident inability to cut expenses, is what worries investors and explains why the 4.8% that France pays today exceeds what is paid by economies that are a priori smaller and less productive, such as Spain, where the interest on ten-year bonds is 4%. Nor does France's sclerotic economic growth since the end of the pandemic help at all: while the deficit has exceeded 5% every year between 2023 and 2025, economic growth has not reached 2%. "It's like your paycheck and your mortgage, it's a problem of scale," comments Ribas: a family may owe more money to the bank than its neighbors, but if at the same time its members also have much higher salaries, it is possible that the family that owes less money may face more difficulties.

A hypothetical debt cancellation

What solutions does France have right now? On the left, the candidate for France Unbowed, Jean-Luc Mélenchon, proposes that the French State cancel 18% of the country's total public debt that is currently in the hands of the Bank of France – which is a public body –, a plan that has the support of former banker Matthieu Pigasse, one of the party's main economic advisors. If it were carried out, this measure would cut the total debt of all French public administrations by about 600 billion euros, which today is about 3.59 trillion euros, according to official data from Insee, the French statistical institute. This reduction, its supporters argue, would mean a relief for the State's public finances and, therefore, would lead to a drop in the interest that the French government currently pays to borrow, since the risk of default would be lower simply by owing less money.

However, this measure is not well regarded by all economists. "Canceling the debt in the hands of the Bank of France is a financial illusion," says Ribas, who shares the view with the Frenchman Olivier Blanchard – a renowned former chief economist of the International Monetary Fund (IMF) – that the benefits would be lower than the problems the measure would cause. Specifically, Blanchard believes that the gains for the French State would be zero, because what the government would save in interest would end up being the same as the gains the Bank of France obtains by charging those same interest payments, and both government and central bank are part of the State's institutional framework.

In addition, the Minister of Finance, Roland Lescure, was also very harsh on the idea, as he considers that it would damage the country's financial reputation. "Canceling the debt is equivalent to saying that we will not pay the people to whom we owe money. Behind the debt there are savers, life insurance and banks. If you say 'we cancel it', you destroy trust," he declared this past August, when Mélenchon made his proposal.

Another issue to keep in mind is that the plan to cancel the debt is, from the start, legally unfeasible, because the Bank of France is part of the Eurosystem, the network of central banks of countries that share the euro as their currency, and which has the European Central Bank (ECB) at the top, which oversees the rest. The same treaties that establish the euro as the common currency of the EU make it clear that the Eurosystem cannot directly finance governments by buying their bonds and cancelling them; a fact, on the other hand, common in most economies of the world since the 80s and 90s.

The role of the ECB

However, regardless of the legal and financial viability of a cancellation of French debt by the central bank, there is one element that is undeniable: the interest rates on French bonds—like those of any country—evolve above all based on how the interest rates set by the central bank perform. Although other factors, both internal and external, can intervene in the final cost a government pays, the general rule is that the central bank has a great deal of power to decide in which direction sovereign debt interest rates move.

The case of France, like that of the rest of the Eurozone states, is no exception, as shown in the attached chart. The moment when this is most clearly seen is during the pandemic: with the lockdowns of 2020, France and the rest of the world entered a very severe recession that impacted two aspects: on the one hand, economic activity was at a minimum and, therefore, so was tax collection. On the other, the government was spending more than ever, with huge tax cuts to help companies and with programs similar to the Spanish ERTEs to ensure that workers who had to stay at home had an income and the economy did not collapse completely.

In those moments of maximum tension for public accounts and with the worst recession in a century, France paid a negative interest rate on its bonds. That is to say, it was paid to go into debt. This was the result of two ECB policies: the first, that the central bank left basic interest rates in negative territory to facilitate credit to the economy and, the second, because it increased its massive bond-buying program of the member states, which kept demand high and, therefore, interest rates on new debt issuances by governments like the French one low.

The difference between five years ago and the current moment is that, now, the ECB is forced to raise rates to curb inflation caused by the war in Ukraine and, furthermore, it has canceled bond-buying programs for years, which is why it does not intervene in the markets as it did during the covid years. And as it had also done during the last years of the debt crisis in the eurozone.

That is why, therefore, apart from the reforms that the French government may make to lighten the burden of its public debt, the French authorities must hope that an eventual change in ECB policy will take pressure off French bonds, although right now it does not seem that the monetary body plans to change course in the near future.