France is on the precipice of a dangerous financial spiral.
The global surge in interest rates has exposed the country, once considered an oasis of relative stability in Europe's financial markets, as one of the continent's weakest links. France now pays more to borrow than former crisis hot spots like Greece and Italy. Its government is running a budget deficit surpassed only by the United States among its peers.
Last week, a slow-burning selloff in France's government bond market took an alarming turn as it spread across the continent, reviving memories of the eurozone debt crisis last decade. France's 10-year borrowing cost has risen toward 5%, the highest level since 2002.
Investors are bracing for things to get worse. The rise in rates is saddling the government with higher costs just as it needs to refinance a mountain of debt borrowed during the era of ultralow interest rates. France has more than $1 trillion in debt coming due by 2030, and next year is set to sell a record of about $380 billion in debt into a market where once-reliable sources of demand have evaporated.
France's central bank is no longer buying government bonds and is instead letting its portfolio shrink as bonds mature. Once-steady investors like Japanese asset managers have also stepped back. Hedge funds that have stepped into the void have been burned by the recent volatility.
"France has been this free rider in Europe for years, if not decades. It has gotten away with fiscal murder," said Kevin Thozet, a portfolio adviser at the French asset manager Carmignac. "It worked as long as people were not noticing. Now people have started to notice."
The cost of servicing France's debt is expected to climb 59% by 2030, according to a recent study commissioned by the French finance ministry. Debt payments are now one of the French government's largest line items and could dwarf military spending by the end of the decade. France's debt, now worth nearly 120% of gross domestic product, risks putting the economy in what its central-bank chief recently called a "gradual stranglehold."
The selloff is fueled by concerns that France has become so ungovernable that its political system can no longer take corrective action. In recent years, lawmakers in the fractious National Assembly have ousted one prime minister after another who attempted to restore fiscal order with spending cuts. With presidential elections approaching in the spring, leading candidates to replace President Emmanuel Macron, who is term limited, are showering voters with promises to expand government spending.
Marine Le Pen, the far-right candidate who is leading in the polls, has vowed to push France's age of retirement as low as 60 years old, a measure she says would cost the state an extra 9 billion euros (about $10.1 billion) a year.
Her closest rival in the polls, far-left leader Jean-Luc Mélenchon, wants the European Central Bank to freeze or wipe away the French bond holdings of the Bank of France, a sum worth 488 billion euros.
"Throw it in the fire," Mélenchon quipped.
The rhetoric, some economists say, is symptomatic of a country that has lost touch with fiscal reality. France's debt woes are rooted in decades of overspending to fund a sprawling welfare system that conditioned the public to expect coddling from the state, particularly in times of crisis. The country hasn't balanced its budget since 1974.
"In France we have this reflex of always asking the state for a bit of magic money -- to pay, pay, pay," said Sylvain Maillard, a lawmaker in Macron's centrist party.
Macron, a former investment banker and technocrat, billed himself as a leader prepared to shock the country back to its senses. He loosened labor-market rules, cut corporate taxes and abolished the country's wealth tax, measures his camp says helped drive growth and bring the deficit below the EU's mandatory threshold of 3% of GDP in the early years of his presidency.
Over the years, however, Macron turned to public spending to solve one crisis after another. The shift began with Macron's unleashing at least 10 billion euros to mollify the violent yellow-vest protest movement, and escalated sharply as France coped with the Covid-19 pandemic and the energy crisis sparked by the Ukraine war.
Macron responded with massive spending programs to shield companies and households from the fallout. Macron coined a slogan for the approach: Quoi qu'il en coûte, or "whatever it costs."
Some measures added financial burdens that would weigh on state coffers well beyond the pandemic, such as an additional 10 billion euro annual cut in corporate taxes and higher wages for workers across France's public healthcare system.
Even temporary measures created lasting strain. France launched one of Europe's biggest paid-leave programs, funding the payrolls of scores of companies, from bistros to large corporations. The subsidies were initially conceived as life support that would end once the pandemic lockdowns were over, but many companies continued to draw on the program for years.
Macron also poured tens of billions of euros into a program that capped energy prices after Russia invaded Ukraine -- subsidies that persisted even as Europe's supplies of natural gas stabilized.
"There was an infusion of public money, and no one in the government had the courage to pull the plug," said Senator Jean-François Husson, a conservative who oversaw a Senate investigation into the spending.
The unprecedented mix of stimulus, inflation and swings in postpandemic demand threw off economic forecasting models that the finance ministry used for annual budgeting. The scale of distortion started coming into focus in 2023 as Macron was weaning the country off the programs.
On Dec. 7, 2023, Finance Minister Bruno Le Maire received a confidential memo from treasury officials warning of a shortfall in tax receipts, according to a copy reviewed by The Wall Street Journal. A windfall tax the government had recently imposed on energy producers -- to help recoup some of its spending on the price cap -- was only delivering a fraction of the 3 billion euros in tax revenue that had been forecast. Value-added taxes were also missing their targets, the memo said, while the cost of government spending had been underestimated by 3 billion euros.
The treasury officials estimated the errors might widen the 2023 budget deficit to 5.2% from the initial forecast of 4.9%, potentially opening a 9.2 billion-euro hole in public accounts. The memo advised Le Maire not to disclose the findings to the public, because the estimates were still clouded with uncertainty. Corporate tax receipts were still unclear from companies that had yet to report their 2023 results.
The timing of the memo was delicate. The National Assembly had just given final approval to the 2023 accounts, casting votes based on figures that now appeared erroneous. The mistakes risked bleeding into budgets for years to come. Prime Minister Élisabeth Borne, meanwhile, was on a tight deadline to push the 2024 budget through the assembly by the end of the year.
Le Maire wrote to Borne on Dec. 13, recommending the government inform the public and make 300 million euros in immediate cuts to the 2024 budget before pushing it through parliament, according to a copy of the letter reviewed by the Journal. He also advised Borne to follow that up with 10 billion euros more in cuts at the start of the year.
Borne was broadsided -- and didn't inform the public. She was in the middle of passing a highly contentious immigration bill that was testing her support in the National Assembly. To get the 2024 budget through parliament, she planned to invoke a special clause of the constitution allowing her government to circumvent a vote on the matter.
"We could no longer change anything in the budget," Borne said in an interview. "We were in the home stretch."
Borne resigned in early January shortly after the budget passed. Macron appointed 34-year-old Gabriel Attal as prime minister, making him the youngest person to ever hold the post in France's modern republic. Under Attal, Le Maire moved to cut billions in spending through executive orders, a regulatory power that doesn't require parliamentary approval.
The state's finances, however, were deteriorating fast. Corporate tax receipts were coming in far below forecasts. Many companies that once relied on paid-leave subsidies and pandemic-era tax benefits were struggling or going out of business. In February, another treasury memo, which was reviewed by the Journal, informed Le Maire that the 2023 deficit could reach 5.6% while the 2024 budget gap might widen to 5.7%, compared with the 4.4% forecast contained in the recently passed budget bill.
Le Maire suddenly had a 40 billion-euro hole to plug, a sum that he argued exceeded the government's power to make cuts without the National Assembly's approval. He began pushing Macron and Attal for new legislation that would correct the 2024 budget with up to 20 billion euros in cuts -- in addition to those he had already made. Macron had relied on a fragile alliance with establishment conservatives in the National Assembly to pass previous legislation, and Le Maire contended that conservative lawmakers would ultimately fall in line with his plans.
Attal opposed Le Maire's approach, preferring to continue using the government's regulatory power to make cuts, according to Rayan Nezzar, Attal's economic adviser at the time. Engaging parliament risked a drawn-out debate with opposition lawmakers who would push for tax increases that could hurt growth, he said, adding that the country at large was in a different mindset.
"'Whatever it costs' was still on everyone's mind, and everyone was still living in a world where money was cheap. Debt was not an issue," he said.