This short note aims to decipher a striking chart related to current economic events. This Killer Chart looks at the rise in 10-year interest rates on French sovereign bonds (OAT10) in September 2024 and the evolution of bond spreads[1] relative to Southern European countries.
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Why is this interesting?
In September 2024, the 10-year sovereign bond spread turned positive between France and Spain (the first time since 2008) and between France and Portugal (an unprecedented event). This means that French interest rates are higher than those in Spain and Portugal. In other words, the financial markets would therefore consider French public debt to be of lower quality than that of the Iberian countries. This situation is all the more worrying given that this same spread is also narrowing with other southern European countries (Italy, Greece), despite their highly fragile public finances.
This deterioration in the perception of the state of French public finances is all the more worrying as it could signal a change in trend, with France no longer benefiting from the same « aura » in the financial markets when it comes to financing/refinancing its debt.
During the sovereign debt crisis in 2012, the financial markets’ assessment of the health of the eurozone countries’ public finances led to a separation between the « core countries » (with sustainable public finances) and the « peripheral countries, » for which the risks perceived by the markets were higher. The peripheral countries included Spain, Italy, Greece, and Portugal. France, on the other hand, benefited from a relatively more favorable position among the « core countries, » even though its public finances had deteriorated (thanks in particular to an « aura effect » and the relative weight of its economy within the eurozone).
For several years, the countries of Southern Europe carried out major budgetary reforms to reduce their public deficits and gradually benefited from more favorable debt conditions. If this gap between France and the countries of Southern Europe were to widen over time, it could be a warning sign of a gradual questioning of the sustainability of public finances in France and the need to introduce budgetary and structural reforms that are likely to be painful.
What should we make of this?
Following the European elections in June 2024, France entered a turbulent political period, conducive to tensions on bond yields and spreads. However, France seems to have been given a reprieve until early September, when the evolution of 10-year yields was close to that of its European neighbors. The late formation of a government has caused a delay in the parliamentary calendar for voting on the 2025 budget, which will in any case result in a significant new public deficit.
It is the combination of this tense political environment, the inevitable widening of the public deficit, weak economic momentum, and uncertainties surrounding the urgency of consolidating public finances that are fueling the current trend in OAT10 spreads. Fears of tax increases in certain categories are fueling a spiral of negative publicity, painting a picture of France on the brink of disaster and facing « bankruptcy, »which tends to muddy the message and potentially perpetuate tensions on spreads.
It should be remembered here that the fundamentals of public debt in France, even if they are deteriorating, remain solid: a broad investor base reflecting a constant and renewed appetite for OATs, yields that are certainly higher but still low, and a rather long average maturity of debt, which reduces the risk of refinancing. The IMF points out that the level of sovereign risk remains low in France.
To preserve these strong fundamentals, it is necessary to reverse the trajectory of the public deficit, which requires fiscal consolidation. However, the urgency of achieving savings must not take precedence over the need to preserve certain categories of public spending that are essential for our long-term growth (education, health, security, and even energy transition). Striving for a primary public surplus, even if we are very far from achieving it, should not be an end in itself, as a surplus offers no particular guarantees in terms of sovereign risk perception and spread reduction (Italy is the best example of this between 2000 and 2019). Furthermore, all debt sustainability analyses highlight that the main direct contributor to reducing public debt is generally real GDP growth, more so than other factors.
The issue of increasing revenue is a thorny one, as demonstrated by the interesting exchanges in the Senate Finance Committee in May 2024, where the elasticity of several categories of public revenue is difficult to assess and the surprise effects on the public deficit are high. If the wealth tax (ISF) were to be reintroduced, it would certainly increase revenues (even if the amount remains limited in relation to current needs), but in order to maximize its effects, its design would also need to be revisited (see the France Stratégie report (2023)). Furthermore, the question of tax consent in a country where the tax burden is among the highest in the OECD would eventually arise.
The design of our public systems is probably the cornerstone of the medium-term recovery of our public finances, in terms of both expenditure and revenue. To achieve this, a systematic evaluation of public policies appears to be the first essential step. These objective evaluations will lay the groundwork for inevitable political decisions to arbitrate and end public programs that generate windfall effects and distortive economic rents, in order to better reallocate public funds.
In an environment of more favorable interest rates, made possible by a more accommodative monetary policy from the European Central Bank, the widening of spreads demonstrates that France is paying a risk premium linked to its political risk. France must therefore also be able to come up with quick solutions to contain its political risk. This political risk is the result of a deterioration in social parameters (e.g., the increase in the number of people living in poverty) but also of a perception of the economic situation that is sometimes worse than it actually is. While French society cannot afford to forego a drastic improvement in the quality of economic debate and education, budgetary measures and reforms must also incorporate greater equity.
V.L
Article completed on September 27, 2024
[1] A spread is a difference in interest rates, calculated in basis points. The spreads mentioned in this article correspond to the difference in interest rates for 10-year bonds paid by France and those paid by other eurozone countries.
[2] The use of the term « bankruptcy » is nonsensical from a semantic point of view (see these insights from BSI Economics on the subject: 1 & 2), which reflects the low level of economic debate in France, the inconsistencies and often unfortunate biases of certain « experts » to the detriment of education and the dissemination of analysis and information.
[3] See Article IV of the IMF of July 2024, with analysis of sovereign risk and the various scenarios on pages 53 to 62.
[4] In particular, it will be important not to repeat the hasty abolition of certain measures without prior in-depth evaluation, as was the case with the ISF (see this evaluation by the Institut des Politiques Publiques in 2021).
