Could France's economic turmoil spark eurozone debt crisis?

Shortly before Francois Bayrou lost a confidence vote in parliament on Monday (September 8), the French prime minister warned that France's fiscal woes would put its "very survival" at risk.

"You have the power to bring down the government, but you do not have the power to erase reality," Bayrou told lawmakers, adding the current reality in Europe's second-largest economy was that "the burden of debt — already unbearable — will grow heavier and more costly."

What happens next is uncertain. Whether new elections will be called, as demanded by the far-right National Rally, or President Emmanuel Macron will manage to install another minority government, is the political side of the crisis.

Economically, it's about money and France's towering debt burden. In absolute terms, no EU country holds more consolidated national debt than France. Sovereign debt has climbed to around €3.35 trillion ($3.9 trillion) — about 113% of gross domestic product (GDP), with the figure expected to rise further to 125% by 2030.

Europe's debt king
France's debt-to-GDP ratio is so high that within the European Uniononly Greece and Italy surpass it. With a budget deficit of 5.4% to 5.8% this year, Paris also runs the largest budget shortfall in the 27-nation EU.

To meet the EU's target of reducing the deficit to 3%, drastic savings are unavoidable.

However, since cuts are currently politically untenable, financial markets have responded with higher risk premiums on French bonds. While German bonds carry an interest rate of about 2.7%, the French government needs to pay close to 3.5% interest for its debt.

So should we worry about the stability of the single European currency, the euro, if the finances of the eurozone's second-largest economy slip out of control?

"Yes, we should be worried. The eurozone is not stable at this point," says Friedrich Heinemann, an economist with the ZEW Leibniz Center for European Economic Research in Mannheim, Germany, even though he is "not concerned" about a new short-term debt crisis in the coming months.

"But we have to ask where this is heading if a big country like France, which has seen a steadily rising debt ratio in recent years, now also faces further political destabilization," he told DW.

Other major economies are also racking up historically high debt and must raise billions on capital markets. This fall, for example, Germany, Japan, and the US will need to issue new government bonds to finance their spending — a key reason global bond markets remain under pressure.

The only reason the markets aren't even more nervous — meaning the spreads on French bonds aren't rising further — is the hope that the European Central Bank will step in and buy French bonds to stabilize the market, Heinemann thinks. "But that hope could be misplaced, because the ECB has to be careful not to undermine its credibility."

It's been a long-standing political dilemma for successive French governments that whenever they propose austerity measures or economic reforms, parties on both the left and right cry foul and mobilize their supporters.

Unions have already called a general strike for September 10, two days after the confidence vote.

European Commission and ECB under pressure
France now spends €67 billion annually just on interest payments. And it is under pressure because it has committed to gradually reducing its deficit in line with EU rules.

But Heinemann also lays part of the blame on the steps of the European Commission because it "helped create this mess."

"It kept turning a blind eye, even both eyes, when it came to France. Those were political compromises driven by fear of strengthening populists," he said, adding that "France has already used up much of its fiscal space. Germany is in a much better position, with plenty of room for maneuver."

Stalled reforms
According to Heinemann, France, like Germany, urgently needs major welfare reforms and spending cuts. The alternative would be higher taxes in a country that already imposes heavy tax burdens on both citizens and businesses.

Therefore, Heinemann is skeptical that French politics can deliver a cross-party consensus on debt reduction. "With populists on both the left and right gaining ground, I don't see that happening. The center is shrinking. That's why I'm pessimistic about France and don't see a solution."

For Andrew Kenningham, chief European economist at London-based Capital Economics, the risks to other European markets remain manageable for now.

"So far, the problems seem largely confined to France itself, as long as the scale of the French issue doesn't grow too big," he said in a note to clients.

But he warned of scenarios where France's crisis could escalate significantly, raising the risk of contagion.

"After all, France is the eurozone's second-largest economy, with deep trade and financial ties to its neighbors, and it is also a leading EU political power," Kenningham noted, saying a crisis in France could therefore put the very viability of the European project into question.

"We don't expect a crisis of that magnitude in the next one to two years. But if it were to happen, contagion could become a much bigger risk — one the ECB would have to address," he said.

Bad timing for a political crisis
France's turmoil comes at a time when the EU is locked in conflict with the United States over trade policy, including higher taxes on US tech giants proposed by France.

It's poor timing for the EU to appear weakened by the political deadlock in its second-largest economy.

For Heinemann, many political actors in France are "Trumpists at heart," especially on the left and right of the political spectrum.

"They could increase pressure on the European Commission to retaliate against Trump's tariffs with European tariffs," the economist warned, which would "raise the risk of a real trade war" and worsen the country's debt crisis even further.

This article was originally written in German. It was first published on September 5, and updated on September 8 after the French prime minister lost a confidence vote in parliament.