France is caught in a doom-loop and its creditors are starting to notice

Demonstrators hold banners and flags as they protest on International Workers' day against the government's pension reform in Paris, France on May 1 - Ibrahim Ezzat/Anadolu Agency
Demonstrators hold banners and flags as they protest on International Workers' day against the government's pension reform in Paris, France on May 1 - Ibrahim Ezzat/Anadolu Agency

Flights were cancelled as air traffic controllers stayed away from work. Many metro stations were shut. The bins remained unemptied, and the streets were filled with protestors.

As France marked the labour day bank holiday yesterday, the rallies against President Macron’s minor tweaks to the pension rules may not have been as violent as some of the riots witnessed during the height of the unrest.

But opposition remains as potent as ever.

The trouble is, this may not be the worst of Macron's challenges. Last week, the ratings agency Fitch downgraded France’s debt, the first major de-rating of a developed economy in years.

And that is just the start. France is now caught in a doom-loop, where even perfectly sensible reforms trigger a wave of protests, forcing yet more downgrades as the impossibility of change becomes clear, which increases the cost of all the money the state has to keep borrowing.

This could end in a full-blown sovereign debt crisis, with Paris at the centre of the storm.

May 1st is typically marked by union-led demonstrations in France. But this year they had extra potency. President Macron’s determination to force through a reform of the country’s hugely expensive pension system without Parliamentary approval has sparked a widespread outbreak of unrest.

The reform itself is both fairly minor and long overdue.

Macron will raise the retirement age to 64 over several years – a lower age than many other major economies.

Yet it was still completely unacceptable to the French public. Macron may well be able to force it through, and survive in office until his term ends.

The trouble is, he is unlikely to be able to make any further changes, and no one can seriously argue the tweaks to the pension system is anything more than a tiny step towards modernising the French economy.

Even worse, global investors have started to notice that France is becoming ungovernable.

As mentioned, last week Fitch downgraded the country’s debt to AA-minus, the latest in a painful series of downgrades since it lost its Triple A status in 2012.

“Political deadlock and (sometimes violent) social movements pose a risk to Macron’s reform agenda and could create pressures for a more expansionary fiscal policy or a reversal of previous reforms,” the agency noted dryly, adding that its “fiscal metrics are weaker than peers”.

It would be hard to disagree with that grim verdict. While other countries, including the UK, are gradually bringing the budget back close to balance, France’s deficit is expected to remain at 5pc of GDP this year, and shows little sign of falling any time soon.

The figures on France’s debt levels are alarming.

Total government debt has risen to 112pc of GDP, in contrast to around 66pc in Germany and 100pc in the UK. And it's rising with every year that passes.

Its government debt has surpassed Italy, in absolute terms, if not as a percentage of GDP, and it is now the third most indebted country in the world after the United States and Japan.

All that debt is mostly owed to the rest of the world.

Indeed, according to figures from the Banque de France from 2021, France by itself accounts for 8.1pc of global debt liabilities, second only to the US, and almost twice the level of Japan. And much of the borrowing is used to support a nation where government expenditure as a proportion of GDP hit 59pc in 2021.

The higher this figure rises, the more it will crush the life out of private enterprise.

France may be home to a few exceptional businesses such as the luxury goods empire LVMH, which recently became Europe’s first company to reach a $500 billion valuation, but if you strip out the fashion houses there are hardly any major industries of any global significance left.

It may have some excellent infrastructure, but it has been coasting on those assets for more than a decade without creating any genuine growth.

Macron implemented a few useful reforms in his first term, especially for smaller and tech businesses, and that has helped bring unemployment down significantly.

But the improvements in its competitiveness have been marginal at best. France still doesn’t have a significant technology industry, its trade deficit is widening all the time, and its joblessness rate remains stuck at a far higher level than most of its rivals.

Macron no longer has any credible plan for bringing the debt down and neither do any of his potential successors.

And even minor tweaks to reduce spending such as the pension reform are virtually impossible. Investors have started to notice.

The yield on the French 10-year bond has been climbing steadily over the last year, rising from less than 1.5pc to close to 3pc.

That makes it more expensive to borrow more, and to keep paying the interest on all the debt it has already accumulated.

Sure, rates have been climbing all over the developed world as interest rates go up, but the spread with German rates – a key measure of how France is viewed in the markets – has been steadily widening as well.

The whole of Europe – including of course the UK – faces a potential debt crisis.

Every major economy has got used to living beyond its means, and the pandemic has only made that worse. Sluggish economies are incapable of generating the growth needed to sustain bloated welfare systems.

But right now France is the most likely country to be at the centre of the storm. Fitch has noticed that reform is now stuck, and warned its clients that the debt is looking less and less sustainable with every year that passes.

The protestors out on the streets again yesterday may ignore that. But the markets won’t ignore it forever.

At some point, there could be a crisis of confidence – and when it comes it will be swift, brutal, and impossible to control.

This downgrade will just be the start of many – until finally someone finds a way to balance the books again.