via notayesmanseconomics:
The calling of an election in France has already caused some questioning of what some regarded as economic certainties. One is the trope represented by the French finance ministry yesterday.
France’s finance minister has warned that the country could face a debt crisis akin to the UK’s gilt market turmoil under former prime minister Liz Truss if the far-right Rassemblement National wins snap elections this month and next.
Of course some of this is politics but there are serious economic and financial points below this.Plus a rather curious move from the former French finance minister in charge of the ECB. Let me illustrate this with the next bit from the Financial Times.
The sell-off has pushed the gap between French and German borrowing costs to its highest level since October. The cost of some maturities of French debt has also risen above those of Portugal, which was bailed out during the Eurozone crisis and had a junk credit rating for much of the past decade.
Both the FT and the French finance minister have rather tripped over their own feet here as not only was the Liz Truss experience supposed to have Brexit as a cause. But France is supposed to be protected from such things by its membership of the Euro. Remember when ECB President Lagarde said “we are not here to close bond spreads” and caused a mini-crisis before being forced to U-turn the next day? Well the spread between France and Germany is one of the core Euro area measures.
10y French government bond yields widened further vs. 10y German bunds to 60bp, up from 55bp on Monday and 47bp on Friday. ( AshendenFinance)
Whilst the move is minor so far it begs a couple of questions. How far might it go and why is it not zero? After all the Euro is supposed to be irreversible.
French Deficit and Debt Problems
Over the years I have found myself noting that the French have pushed the Euro area borrowing rules to the limit and sometimes beyond. At the end of last month Standard and Poors joined the party.
France Long-Term Rating Lowered To ‘AA-‘ From ‘AA’ On Deterioration Of Budgetary Position; Outlook Stable
It may have been a surprise to S&P but followers of my work will not be surprised by the number below.
France’s 2023 budget deficit was significantly higher than we previously forecast, reaching 5.5% of GDP.
Indeed we now get a bit of revisionism.
Although we expect the recovery of economic growth and recently implemented economic and budgetary reforms will allow France to reduce its budget deficit, we now forecast it will remain above 3% of GDP in 2027.
So as you can see the French finance minister Bruno Lemaire was throwing stones from a glasshouse with his comments. Plus there was more.
The above mentioned budgetary slippage was mainly due to lower tax revenue than budgeted, while spending as a percentage of GDP remained high (the highest in the EU and among the highest across all sovereigns we rate).
France’s fiscal profligacy has been a feature of his government and there is another factor here as the tax revenue point is another way of saying low economic growth. However Standard and Poors then choose to add a splash of Hopium.
The stable outlook on France reflects our expectations that real economic growth will accelerate and support the government’s budgetary consolidation,
We can review that in the light of the next forecast.
We now expect general government debt (excluding guarantees related to the European Financial Stability Facility) will reach 112.1% of GDP in 2027, up from 109.0% in 2023. France’s general government debt-to-GDP ratio has become the third highest in the euro area after that of Greece and Italy.
It is interesting that they want to exclude “Euro solidarity” debt which adds another 1.7%. But my main point here is that the French debt ratio has been singing along with Paul Simon.
Slip slidin’ awaySlip slidin’ awayYou know the nearer your destinationThe more you’re slip slidin’ away
The official position is that a decline in the ratio is just around the corner but the reality is that it keeps edging higher. These days there is a genuine cost to this because France has a benchmark ten-year yield of 3.17% as I type this. So as it borrows and renews maturing debt things are getting quite a bit more expensive. It will still be benefiting from the period when the ECB drove its bond yields incredibly low as it was paid to borrow for a while. But new borrowing is much more expensive.
If we stay with this issue I note that the Governor of the Bank of France unintentionally trod on a landmine on Tuesday.
A large US fiscal deficit tightens financial conditions and fuels US inflation. According to the IMF it is expected to reach close to 6.5% of GDP in 2024, whereas the fiscal deficit in the euro area should stand at 2.9% of GDP.
So France is fueling inflation with its fiscal deficit.
Bank of France
The other side of France being able to borrow cheaply is that the Bank of France now has some very expensive government bonds on its books. We can look at this via the way it presents it.
Between 2015 and 2022, the Banque de France paid a cumulative total of almost EUR 32 billion to the state in corporation tax and dividends (2022 Annual Report). The annual breakdown shows that a peak was reached in 2019, when more than EUR 6 billion was paid.
As you can see that will have made the Governor of the Bank of France very popular with the government. A master of the financial markets!
Whereas losses can safely be ignored.
The Banque de France is starting this period in a relatively favourable position, which it had built up over the past few years. It was able to draw on its Fund for General Risks (EUR 16.4 billion at end-2022) to cover a gross loss of EUR 12.4 billion for 2023.
Pure asymmetry….
ECB Problems
Whilst the public tool has remained a mythical beast as the Transmission Protection Instrument has yet to be used, the ECB has acted more privately. As the bonds bought in the QE programmes mature they are reinvested. As these were vast in size with the APP at 2.27 trillion Euros and the PEPP at 1.66 trillion this gave the ECB flexibility to support some bond markets (Italy) at the expense of others (France and Hermany for example). As you can imagine it may well be regretting the move on French bonds but there is more.
and to reduce the PEPP portfolio by €7.5 billion per month on average over the second half of the year. At the same time, the Governing Council announced that it intends to discontinue reinvestments under the PEPP at the end of 2024.
Last week it announced plans for QT which reduce and then will end the flexibility it previously had. Just as it might need it…..
Comment
There is an underlying theme here of a lack of economic growth. The French flavour in this has been to be fiscally expansive which is why there are debt issues. This adds another nuance as this fiscal policy has not generated much growth. Another context on the words of the Governor of the Bank of France I quoted might be to point out that the US has at least got some significant growth in return for its fiscal largesse.
The next issue is that any policy that looks for change as in more economic growth gets rejected by the establishment. Some think this creates a doom-loop of poor economic growth and more debt issues. Let me be clear I an not advocating for either Liz Truss or Madame Le Pen but simply wondering why apparently only more of the same failed polices is just fine? Indeed we have one only this week.
The European Commission formally notified automakers incl BYD, Geely, and MG owner SAIC Motor of the additional levies on EVs, which will take tariffs to as high as 48% from next month. German manufacturers that produce in China also have to pay tariffs and at the same time fear that China will take countermeasures to affect Chinese sales. ( @Schuldensuehner)
Finally some of this issues are also a matter of perception as there is a fair dose of psychology involved in bond markets. But many players are intelligent and thus will be spotting the inconsistencies I have pointed out today.