France is facing a significant political crisis – how will French investments be affected?
3 DEC, 2024
By François Rimeu from La Française
François Rimeu, Senior Strategist at Crédit Mutuel Asset Management
At the time of writing, France’s 2025 budget proposal is being reviewed by the Senate, which could reverse the initially planned spending cuts. The European Commission, for its part, has supported the government, praising its austerity efforts, while Marine Le Pen threatens to bring down the government by backing a vote of no confidence with the Left Party (Parti de Gauche) unless certain measures (notably the increase in taxes on electricity) are withdrawn.
France is currently facing a political crisis like few others under the Fifth Republic, coupled with an equally worrying economic situation. Recent Purchasing Managers' Index (PMI) data for France shows a deteriorating situation with little prospect of reversing this negative trend in the short term.
Since the announcement of the dissolution of the National Assembly last June, French assets have significantly underperformed their European counterparts:
- From 10 June to 26 November, the CAC 40 dropped by -8.3%, while the Stoxx 600 only fell by -2.3%.
During the same period, French debt has also come under pressure:
- The spread between the 10-year OAT (French government bond) and the Bund (10-year German government bond) increased from 0.47% to 0.82%;
- The spread between the 10-year Spanish Treasury bond yield and the OAT reduced from 0.25% to -0.10%;
- The spread between the 10-year Italian government bond yield and the OAT reduced from 0.84% to 0.44%.
Thus, the questions we face today are: What are the possible scenarios, and what are the potential consequences?
We see two possible scenarios with multiple implications:
- The efforts made in the budget are insufficient for the National Assembly’s taste, and the vote of no confidence passes.
- The Barnier government approves a more or less modified budget through Article 49.3 of the Constitution and survives a potential vote of no confidence (certainly with an abstaining National Assembly).
Before considering these scenarios and their possible consequences, it is worth recalling some data about France:
- Debt-to-GDP ratio: 112.7%
- Estimated budget deficit for 2024: -6.2%
- Estimated primary deficit for 2024: -4% (the worst in the eurozone alongside Slovakia; for comparison, Italy stands at -0.4%)
- Expected budget growth for 2025 (according to the budget proposal): +1.1%
Scenario 1:
At present, we believe there is a 50% probability that the Barnier government could fall. Investment banks appear slightly more optimistic, with a medium probability around 30%. In this scenario, it seems likely that the OAT-Bund spread at 10 years will initially increase to 95-100 basis points (bps) and that French equities will deliver returns inferior to other European indices, between 2% and 3%.
The next logical step would be to activate Article 47 of the Constitution, with a new government implementing its policy (and therefore the budget) without a vote. It is important to note that this would only be possible if the Parliament does not reach a decision. However, a Parliament that rejects a text is, in fact, a Parliament that has made a decision, rendering this provision inapplicable. The next step would be a debate among constitutional experts, which we are not, potentially leading to very unstable times.
Uncertain times lie ahead for France, likely negative for growth prospects, with little chance of stabilisation before the July elections. In this context, rating agencies would logically be harsh on France and would most likely downgrade its rating.
Scenario 2:
In the second scenario, where the Barnier government survives a vote of no confidence, there would inevitably be a general sense of relief and, therefore, a rebound in French markets. A return to around 70 basis points in the OAT-Bund spread at 10 years seems possible, along with a slight rebound in French equities, around 1-2%. However, this relief is likely to be short-lived:
- Firstly, because the survival of the Barnier government would be linked to the cancellation of the planned spending cuts, which would automatically raise the estimated budget deficit for 2025 (currently at -5% at best).
- Secondly, because these deficit calculations are based on growth projections of 1.1% for 2025, which we believe to be optimistic. Sadly, growth of around 0.6-0.7% seems more realistic.
- And lastly, because the upcoming July 2025 elections are likely to weigh on investors' intentions to increase investments in French assets.
Even if the rating agencies gave France more time, they would likely only postpone the loss of its AA rating until later, when deficit targets are not met due to overly optimistic growth objectives.
As can be seen, we remain very cautious regarding French assets. The challenges facing the French economy are daunting: ageing population, debt, lack of productivity, etc., not to mention that these problems are present in most European economies, and the geopolitical situation is, at best, unstable.
