Is France at an increased risk of a financial crisis? It’s a question that few observers are asking, but there are three reasons for potential concern:
- French debt levels have spiralled higher over the past decade, even when much of Europe has deleveraged.
- The European Central Bank (ECB) has indicated that it will start raising rates in July, and this could increase the cost of financing debt over time.
- After the June 19 legislative elections, passing additional reforms that might reduce public debt and spur economic growth could become more difficult.
France’s Rising Debt Levels
Over the past two decades French debt levels have steadily increased. At the beginning of the new millennium, France’s total public and private sector debt burden was 186.7% of GDP. By end of 2021, France’s debt-to-GDP ratio had risen to 347.7%, according to data from the Bank for International Settlements (BIS). Currently, France has higher overall debt than any other eurozone nation, including Portugal, Ireland, Italy, Greece and Spain, all of whom encountered severe financial problems in the years following the global financial crisis (Figure 1).
Figure 1: France is Europe’s Most Indebted Nation
Debt has risen across all sectors of the French economy since 2000. Public sector debt has increased from 59.3% to 113.3% of GDP. Household debt has doubled as a portion of the economy from 33.9% to 67.1% today. Finally, French corporate debt has grown from 93.5% to 167.3% of GDP (Figure 2).
Figure 2: French Debt Has Nearly Doubled Relative to GDP Since 2000
Also of note is the trajectory of French debt relative to its eurozone peers. During the first decade of the eurozone’s existence, the rise in debt levels generally across Europe and France wasn’t particularly exceptional. However, over the last decade, the eurozone debt ratios have been stable overall, and there have been four remarkably different debt trajectories among the member nations:
- Highly indebted nations have deleveraged (Ireland, Netherlands, Portugal and Spain – Figure 3).
- Lower-than-average debt nations have kept debt levels low (Austria and Germany – Figure 4)
- Higher-than-average debt nations that have not deleveraged (Greece and Italy – Figure 5)
- Nations that have continued to lever up (Belgium, Finland and France – Figure 6)
Figure 3: Certain nations used the period of low rates to deleverage
Figure 4: Germany and Austria have kept debt levels low
Figure 5: Italy and Greece have maintained average or above-average debt ratios
Figure 6: Belgium, Finland and especially France have sharply increased debt ratios
One factor that could work in France’s favor is the mix of its debt. A large share of France’s debt is in the non-financial corporate sector and it’s not clear whether gross domestic product is the right yardstick especially since France is home to many large multinational corporations. To the extent that their debts are matched by revenues earned abroad by foreign subsidiaries and affiliates, their debt levels might be more manageable than their ratio to France’s gross domestic product would suggest.
That said, there are plenty of examples of private sector debt being brought into the public books in the event of financial stress. That happened in the U.S. with Fannie Mae and Freddie Mac in 2008 and in Ireland, Spain and the United Kingdom when their banks ran into trouble during the global financial crisis, some of which wound up being nationalized.
There are also more subtle ways of bringing private debts into public accounts. When the private sector runs into trouble, the government can increase spending and/or cut taxes, running larger deficits which increase public debt while the private sector attempts to deleverage. This occurred in Japan over the past several decade as public debt ballooned from 60% to over 200% of GDP. This, however, is more easily done in nations like Japan and the U.S. where a sovereign issues debt into a currency controlled by that nation’s central bank. This is not the case in the eurozone where the “sovereign” bond market resembles a municipal debt market with many governments issuing debt into a common currency that none of them directly control.
High Debt Levels in a Rising Rate Environment
Increasing leverage and taking on a great deal of debt isn’t necessarily a problem so long as the cost of financing it remains low. In fact, during the past decade not only was the cost of financing debt low, in the case of the French public sector it was often negative. Beginning in late 2014 the European Central Bank (ECB) began to experiment with negative interest rates. This enabled the French government to finance itself with short-term debt at rates slightly below zero. Between mid-2019 and mid-2021 even French 10-year bonds often had negative yields, and the French Treasury issued multiple long-dated bonds with coupons of between zero and 0.5% per annum. While many eurozone nations used this period of low yields to deleverage, the French government and private sector used it as an opportunity to increase leverage, allowing the country to live beyond its means for the better part of the past 10 years.
This appears likely to change. ECB Chair Christine Lagarde put markets on notice that the ECB intends to raise rates by a quarter percent in July, followed by a possible 50 basis-point rise in September (Figure 7). Moreover, futures markets in the eurozone suggest that traders, for the moment, see rates eventually rising to over 2%. Over time such a development would raise the cost of borrowing across all sectors of the French economy, causing them to become potentially more prone to financial stress.
Figure 7: Eurozone rates could rise to over 2% as soon as next year.
This is not to suggest that France is in imminent danger of a financial crisis. If it does happen, it could be several years in the future. Debt crises tend to happen towards the end of (or even after) central tightening cycles. The ECB’s tightening cycle hasn’t even begun. However, France’s potential debt problems could be exacerbated if the government is not able to make key structural reforms that could reduce budget deficits and improve the pace of economic growth.
An Evolving Political Situation
On Sunday June 19 French voters elected a new National Assembly and the vote produced changes that are unprecedented in the 64-year history of the Fifth Republic. For the first time, there is no clear majority party or coalition.
French President Emmanuel Macron’s parliamentary group, Ensemble, captured 246 seats, a loss of 101 seats from 2017, and 43 seats short of a majority. Les Republicains, the center-right party of former Presidents Jacques Chirac and Nicolas Sarkozy, lost 56 seats, leaving them with 64 seats. In theory, these two political groups could form a coalition government but, for the moment, Les Republicains have gone on record as publicly opposing entering into a coalition with Macron’s forces, stating that they will be a party of opposition.
The lack of a majority party in the National Assembly could make it difficult to pass reforms such as raising France’s retirement age from 63 to 65, a move that would expand labor force participation as well as reduce public spending on retirement programs. The difficulty of enacting this and other structural reforms could make it more difficult to deleverage the French economy or to respond to economic stress resulting from the combination of higher interest rates and elevated levels of leverage.
Managing Interest-Rate Risk
Eurodollar futures and options are a cost-effective way to manage risk for short-term interest rates.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.