Macron’s snap election could trigger the next debt crisis

Results in this weekend’s first round of elections in France have the potential to ignite a financial crisis in the country and pose a significant threat to the stability of the eurozone and its single currency.

On Sunday, the French will vote in a snap election called by President Emmanuel Macron after his Renaissance Party was swamped by right-wing parties in the recent European Union parliamentary elections. The second round of voting will be held on July 7.

According to all the polls, the hard-right National Rally party headed by Marine Le Pen is well ahead of a coalition of leftist parties, with Renaissance limping in as a poor third.

While the election doesn’t threaten Macron’s position, it could lead to a dramatic shift in France’s economic policies.Credit: AP

While the election doesn’t threaten Macron’s position – the presidential election won’t be held until 2027 – it does, if the polls are correct, raise the prospect of either a dramatic shift in France’s economic policies or, perhaps worse, a completely ungovernable state. Macron’s influence on economic policies would be limited, although he would retain primary responsibility for defence and foreign affairs.

France’s starting point is fragile. The improved fiscal discipline Macron promised when he took office in 2017 was derailed by the country’s response to the pandemic, Russia’s invasion of Ukraine and rising inflation.

France’s budget deficit has blown out to 5.5 per cent of GDP, well above the European Union’s 3 per cent limit. Its public debt is 122 per cent of GDP, compared with an average of 90 per cent across the eurozone and less than 65 per cent in the other eurozone heavyweight economy, Germany.

Even as Macron, who had previously planned to cut more than €20 billion ($32 billion) from government spending, has now vowed to cut energy and housing costs, his rivals are promising more. A lot more.

Le Pen’s National Rally has said it will cut the value-added tax on energy, fuel and food from 20 per cent to 5.5 per cent. It would reverse Macron’s controversial raising of the retirement age from 62 to 64 and lower it to 60 for those who started work at 20, increase minimum pension rates, cut payroll taxes, shave €2 billion to €3 billion off France’s €21.6 billion contribution to the EU budget and increase taxes on energy companies. It also wants to nationalise France’s motorways and, of course, plans a crackdown on immigration and illegal immigrants.

The cost of RN’s spending has been estimated at more than €74 billion a year, with a net cost of €18 billion a year without factoring in the cost of the changes to pensions. France’s annual deficit would rise to about 6.4 per cent of GDP by 2026.

There is no detailed plan for funding the party’s proposed measures.

It is probable ... there would be such a splurge of reckless spending that it could plunge France into a financial and economic crisis.

The leftist grouping, the New Popular Front, has even more expansive plans, also unfunded.

It plans to freeze the prices of fuel, basic foods and energy. It wants to increase the minimum wage by about 15 per cent, increase public sector wages and housing benefits, roll back the retirement age and fund free state school meals and supplies, among other promises.

The New Popular Front says it will pay for the increase in spending – an increase of €150 billion a year by 2027 – with wealth taxes, exit taxes, the abolition of France’s 30 per cent tax on financial income, an inheritance tax and a tax on “super profits”, along with the growth in the economy it says will flow from the increased spending.

It is probable that, if either of the extremes of the political spectrum were to gain a majority in the national assembly, there would be such a splurge of reckless spending that it could plunge France into a financial and economic crisis.

Its debt would blow out and, as the initial reaction of European bond markets to the announcement of the election signalled, there would be a material increase in the interest costs of France’s sovereign debt that would compound and spread its financial effects throughout the economy.

The impact of France’s debt and deficits has been muted in the past because it has been able to borrow at rates close to those of the most conservative economy in the eurozone, Germany.

The spread between yields on German and French bonds has been widening – about 75 basis points at present – but that could blow out significantly if France abandons all fiscal discipline.

A win for either of the more profligate parties would also entrench France’s defiance of the EU’s fiscal rules, risking European Commission financial sanctions (not that the NR would care about anything the EU might do, given Le Pen’s disdain for the union and the single currency).

In the event of a sovereign debt crisis similar to those seen within the eurozone in the past in Greece, Spain and Portugal, the European Central Bank can now intervene and buy bonds to temper the spike in yields and interest costs, but it would be reluctant to come to France’s aid unless a clear pathway to financial stability was on offer.

The Germans could be counted on to oppose a bailout caused by a spendthrift France, although the single currency and Germany and France’s roles as the biggest economies within the eurozone and the most significant determinants of the euro’s value mean that any significant problems within the French economy become a threat to the stability of the entire zone.

Macron’s finance minister Bruno Le Maire has warned that a win by either the far right or the far left could trigger a debt crisis that would lead to an intervention by the International Monetary Fund and/or the European Commission. He has likened the prospect of a bond market reaction to what happened to cut short the brief tenure of British Prime Minister Liz Truss.

Truss’s big-spending, unfunded mini-budget in 2022 ignited a bond market meltdown, with yields soaring, and threatened to blow up the entire British pension fund sector and create a banking crisis.

The UK was fortunate to have its own currency and central bank to respond to the crisis, and a system that saw Truss resign without causing a political crisis.

None of those are features of the French financial or political system.

A fiscal and financial crisis in France would rapidly become a fiscal and financial challenge for the eurozone and its institutions and, indeed, for the future of the larger “European Project”, as Germany and France provide its foundations.

The least bad result for France and the eurozone might well be a hung parliament, with none of the parties able to form a government in their own right.

That would be a poor and challenging outcome for France, given its unstable finances and the lack of social cohesion highlighted by the popularity of the extremist parties in the lead-up to the election.

But it might still be better than, if the polls are a guide, the likely alternatives.

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