France’s political turmoil is casting a shadow over economic growth

French lawmakers are expected to hold a vote of no confidence in Prime Minister Michel Barnier’s weak minority government on Wednesday. That’s because economists warn that political deadlock will have high economic costs.

The two so-called ‘censure motions’ submitted by the left-wing and far-right opposition parties will begin discussion and voting starting at 4pm local time. There is widespread speculation that the regime is likely to be ousted just three months after its inauguration. If the government falls, Barnier would be forced to tender his resignation to President Emmanuel Macron after failing to find compromise within the deeply divided National Assembly to pass a 2025 budget bill to reduce France’s huge deficit.

There uncertainty reigns. Macron will eventually have to name a new prime minister after already struggling to appoint one after a summer snap election that gave the left-wing coalition the most votes but failed to give any party a majority. Minister Barnier has been seen as a technocratic compromiser.

“If Barnier resigns, Macron will ask him to continue in a caretaker role,” Carsten Nickel, Teneo’s deputy director of research, said in a note Tuesday. “The alternative of formally re-nominating Barnier is unlikely given the apparent lack of a majority.” “It looks low,” he said.

This caretaker status could last for months, as new elections cannot be held until next year, Nickel said, while another possibility is that Macron’s resignation could trigger a presidential election within 35 days.

He added that such a chain of events would leave the budget unpassed and make a last-minute deal seem impossible.

The interim government is therefore likely to submit a special constitution “that would effectively roll over the 2024 fiscal without any of the spending cuts or tax increases previously expected, while also giving the government the power to continue collecting taxes,” he said.

Amid the chaos, France’s borrowing costs rose and the euro was hit by a negative sentiment. This was further exacerbated by political volatility in Germany at the same time as dismal manufacturing data in the euro area.

“Amid this uncertainty, France faces the prospect of rising fiscal deficits and higher financing costs as (government bond) yields rise,” Maybank analysts wrote in a note Wednesday.

Javier Díaz-Giménez, an economics professor at Spain’s IESE business school, told CNBC by phone that the situation in France is “very bad” for international investors.

“If you don’t have a budget, you actually default – not because you can’t pay the interest on your debt, but because without a budget you won’t. The rating agencies are already sounding the alarm, and the premium on a 10-year French government bond is higher than the 10-year premium.” “Greece is a crazy country fundamentally,” he said. Greece briefly lost its investment-grade credit rating due to the euro zone debt crisis, which led to the country defaulting on its debt.

“But that’s because pension funds don’t care. They just want a guaranteed return without worrying about legal nonsense. So they’ll dump (French bonds) and go somewhere else,” Díaz-Giménez said.

“Beyond economic growth and stability, France’s debt will become unsustainable.”

Economists have already downgraded their growth forecasts for France since the budget proposals were announced in October, taking into account the country’s massive tax hikes and public spending cuts.

Analysts at Dutch bank ING, who had previously expected French growth to slow to 0.6% in 2025 from 1.1% in 2024, said on Tuesday that the fall of Barnier’s government “would be bad news for the French economy.”

They also predicted the passage of an interim budget reflecting the 2024 framework.

“Such a budget will not correct the trajectory of public spending,” they said, dismissing Barnier’s target to reduce the public deficit from 6% to 5% of GDP in 2025. This means that France will not be able to achieve the European Union’s new targets. Financial rules.

“This is bad news at a time when economic growth in France is slowing noticeably. The public deficit will remain high, debt will continue to rise and the next government will have the much more difficult task of deploying public finances at any time. ING analysts said.

“France can count on large reserves of domestic savings to displace international investors, and euro area data flows will help decouple European and U.S. yields, but in the medium term the government will be able to “Having too much domestic savings compared to financing can be costly in terms of growth dynamics.”

“Consumer confidence has already fallen and savings rates have risen further, which could hamper the consumption rebound the government is hoping to support with tax receipts in 2025,” Moek said.

The gap between Germany and France’s borrowing costs rose to a 12-year high this month, with both countries mired in political turmoil.

But IESE Business School’s Díaz-Giménez said that in some ways France’s outlook is more positive than that of the euro area’s largest economies.

“The economic outlook for France is very bleak, but it will not be a disaster if we can avoid the attendant risks. The high fiscal deficit is difficult to solve and requires political harmony, but we can still find ways to overcome it, but it will not be a disaster if we can avoid it.” “We just need politicians to do their job and address the real problem, which is fiscal sustainability,” he told CNBC.

“But Germany’s problem is growth. The German economy needs a massive adaptation to a new environment where there is no Russian gas and making cars in Europe seems like a really bad business plan. From an economic point of view, this is harder to solve. “It’s a difficult French problem.”