Why France's Debt Crisis is a Problem: Political Paralysis and Market Anxiety

[Mexico City = Shim Young-jae, Correspondent] France's financial instability and political turmoil are increasing tensions in the bond market. Investors are demanding higher interest rates for holding French government bonds, widening the yield gap with German bonds to its largest level since the European debt crisis of the 2010s. Concerns are also emerging that instability could spread to other high-debt European countries like Italy.

According to Axios, on the 5th (local time), France is facing both debt issues and social unrest ahead of next year's presidential election. The combination of expanding fiscal deficits, rising costs due to an aging population, political polarization, and increased energy costs from the war in Iran, along with economic slowdown, is raising concerns about France's fiscal health in the market.

Rising Risk Premium on French Bonds... Widening Yield Gap with Germany

Axios reports that while bond yields are rising across Europe and the United States, the situation in France is more severe.

Investors are demanding higher yields as compensation for holding French bonds. Compared to German bonds, which are considered safe assets, the market's wariness of risk is becoming more pronounced.

On the 2nd, the spread between French and German bond yields widened to its largest level since the European debt crisis of the 2010s.

Thierry Wizman, a strategist at Macquarie, analyzed in a report that the widening spread is due to the increased risk of French sovereign default.

Robin Brooks, a researcher at the Brookings Institution, recently stated that French bond yields are rising to a level that is difficult to control, diagnosing that instability is rapidly spreading to other high-debt European countries.

Evercore also reported that investors are concerned about the possibility of a fiscal crisis that could shake the legal framework of the European Union (EU). This is particularly seen as a worrying signal of contagion that has begun to appear in Italy.

France's fiscal burden is not a recent issue. Axios identified the expansion of fiscal deficits, rising costs due to an aging population, and political polarization as major pressures.

The war in Iran has further exacerbated the situation. Rising energy costs and slowing economic growth have made existing fiscal problems even more burdensome.

Social tensions are also increasing. Last week, high school students across France protested, with some protests turning violent.

Political Paralysis Ahead of the Presidential Election... Market Questions Fiscal Control Ability

The French government is trying to reassure investors by cutting the budget.

However, according to Axios, the government is in a position where it is virtually unable to actively pursue policies before next year's presidential election, increasing market anxiety.

Gianluca Benigno, an economics professor at the University of Lausanne, described the trigger for current market anxiety as "political paralysis."

The market is reflecting in prices whether France actually has the ability to control spending.

The fiscal solutions proposed by candidates ahead of the election are also greatly divergent. According to Axios, Marine Le Pen is leading in polls and has proposed enshrining the so-called "golden rule" of limiting fiscal deficits in the constitution. This plan aims to curb spending while also promoting tax cuts.

Jean-Luc Mélenchon has proposed burning the French bonds held by the French central bank. According to Axios, the amount held by the central bank accounts for about 18% of the total French national debt.

Meetu Gulati, a professor at the University of Virginia School of Law, explained that as the fiscal crisis worsens, policymakers tend to choose more extreme solutions.

Professor Gulati is an expert in sovereign debt who participated in the development of Greece's sovereign debt restructuring plan in 2012. He stated, "Bad financial conditions lead to absurd solutions."

Will U.S. Treasuries Still Be a Safe Haven? Possibility of ECB Intervention

If France's instability spreads outside Europe, there may be interest in whether a movement of safe assets similar to the past will occur.

During the European debt crisis of the 2010s, investors moved to U.S. Treasuries. As funds flowed into U.S. Treasuries, bond yields dropped significantly.

However, Axios points out that this time, the U.S.'s status as a safe asset is not as certain as it was then.

Currently, the yield on U.S. 10-year Treasuries is higher than that of French bonds. If France's problems worsen, it is uncertain whether investors will buy U.S. Treasuries on a large scale as they did in the past. However, Axios noted that the current situation is still in its early stages and that there is a high likelihood of intervention by the European Central Bank (ECB).

The causes of this situation are also different from those of the European debt crisis of the 2010s.

Developed countries are adapting to a new interest rate environment after the era of borrowing at ultra-low rates has ended.

Axios analyzes that France's fiscal deficits, aging costs, and political uncertainty are exacerbating the pressures in the bond market.

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