Could France's political turmoil spark eurozone debt crisis?

The common European currency, the euro, fell against main rivals and French borrowing costs spiked as Sebastien Lecornu, who had been 's prime minister for less than a month, resigned on Monday (October 6) — just 14 hours after naming a largely unchanged cabinet.

However, shortly after quitting, Lecornu accepted a request from French President Emmanuel Macron to work on a plan for the "stability for the country" by Wednesday evening.


That unexpected twist capped a day of political upheaval which saw stocks fall sharply on the Paris exchange amid concerns over the political parties' ability to tackle the country's economic woes.

While it’s unclear what will happen if Lecornu fails, one option would be for Macron to call fresh legislative elections.

French politicians are divided on how to tackle the nation's huge sovereign debt pile. As a result, the yield on France's benchmark OATS government bonds rose far more than other eurozone bond yields.

Further indication that investor confidence in Europe's second-largest economy is shaken is the fact that OATS now trade at a slightly higher spread than the BTP government bonds of highly indebted Italy for the first time since the launch of the euro in 1999.

Unsettled by the recurrent political instability, investors have shunned French stocks, with the country's bluechip CAC 40 index lagging the rest of Europe by some 14 % since the beginning of last year.

France: Europe's debt king

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.

France's debt-to-GDP ratio is so high that within the European Unionthat only 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 France's finances slip out of control?

"Yes, we should be worried. The eurozone is not stable at this point," says , an economist with the 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 (ECB) 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.

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. "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 call into question the very viability of the European project.

"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 France.
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.