With public debt at 115% of GDP and persistent deficits, France faces growing scrutiny from sovereign bond investors. Ricardo Castillo, Head of Investments, examines how fiscal pressures, reliance on international capital and changing perceptions of risk can influence French borrowing costs.
A long-standing fiscal challenge
Global yield rising is a major macro topic currently. Today we will focus on the world 4th larger issuer, With 4.1trl USD equivalent of debt outstanding, France. For the context:
Its annual budget deficit has been below the 3% line only 6 times in the las 25 years and closer to the 5% mark in the last 5 years. Its debt now reaches 115% of GDP.
In the last 20 years it has run an account deficit and only grew its economy by an average of 1%.
Public finances return to the political debate
The situation and the negative trend are not new and that is once again the context under which next May presidential and legislative elections will take place.
This topic has seldom been the dominant driver of political discussions in France, dwarfed by more tangible topics like buying power, taxes, retirement, immigration, security… except maybe 14 years ago amid the European debt crisis when all candidates had to take a stance. At the time, the future winner, Mr Francois Hollande coined the famous phrase “my real enemy is the finance world”, most probably pronounced for electoral reasons by a left-wing candidate with pressure on his left. If it was not for Mario Draghi bumblebee speech a few months later, who knows how it would have turned out.
Here we are, 14 years later, and the public finance discussion is centered around the possibility of cancelling the debt currently held by the French central bank in name of the ECB.
I will not enter the debate around its feasibility or consequences; I personally believe that it is adventurous to say that something is impossible in our economy or politics today.
Why international investors matter
Now, let’s try to take the point of view of this finance world, far from any ideology or economic dogma. Foreigners hold more than 50% of the French debt, most of them are not captive buyers, which means they can choose to lend to France or to any other European countries or even outside Europe.
The best rated issuers are Germany and the Netherlands, those are the risk free issuers. if you decide to lend to the others like, Spain, Italy or France then you ask a premium, which mean more interest, in finance terminology a spread over what you ask Germany for the same maturity.
When higher yields reinforce fiscal pressure
This spread widens or reduces in function of the perceived additional risk lending to those countries mean. Public election debate dominated by debt cancelation instead of discussing the control of deficits does not help reassure foreign lenders who are tempted to avoid the noise and play safe lending to France’s neighbors. With marginally less lenders interested in French paper, and with always more need for financing, French yields go up, which contributes to increasing deficits. A rather nasty feedback loop.
Competition for capital
Don’t get me wrong, we are not even close of discussing default of any kind. French bonds are a deep and very liquid market, and France is a A+ issuer. But when you depend structurally on international players to finance your deficits, you need to understand that there is competition for capital, at a regional and global level and that means that you will have to pay more than your competitors to access capital if what you do.. or say... adds risk for the lender. Like the majority of the debt buyers we fiduciary invest in sovereign bonds, which is in many case the “safe” part of the portfolios, there we don’t really like the noise. Unfortunately, we believe the road leading us to the elections might by bumpy reason why we decided to prefer European AAA vs France.
