Concerns are mounting among France's European Union partners and financial markets that the instability of its minority government could hinder efforts to stabilize its public finances, potentially jeopardizing the EU's new fiscal rules.
France unveiled a new government on Saturday, led by Prime Minister Michel Barnier, which will have to rely on the far-right National Rally in key votes like the 2025 budget or the seven-year debt reduction plan required by EU rules.
Both the far-right and the far-left – each with around one-third of the seats in parliament – oppose spending cuts, even as France's budget deficit is set to rise to around 6% of gross domestic product (GDP) this year, twice the EU limit.
"The political fragility of the coalition is clear," said one eurozone official, who, like others interviewed for this story, requested anonymity because of the political sensitivities involved.
"I would not say that expectations are overly optimistic."
The European Commission reckons France's public debt, at 110.6% of GDP in 2023, will rise to 112.4% this year and 113.8% in 2025 unless action is taken. EU rules require a fall of 1% point of GDP a year.
"This is a real dilemma, obviously. Putting together a debt-cutting plan that is both compliant with the new framework and politically acceptable in the hostile French parliament is going to be extraordinarily difficult," a second euro official said.
"In the end, one needs to hope that there is sufficient realization in Paris that the cost of failure could be very high, and that will encourage some parties to at least temporarily lend their support to the government," he said.
'Grave' situation
Market concern about French public finances is pushing the country's borrowing costs higher.
The yield on France's 10-year bonds briefly rose above Spain's on Tuesday for the first time since the 2008 financial crisis.
Spanish bonds have traded with higher yields than French bonds since the financial crisis as the country is traditionally seen as a riskier investment.
However, the so-called spread between Spanish and French 10-year bonds briefly fell into negative territory in morning trading in Europe, with both trading around 2.98%, before rising again to stand at around 1.5 basis points.
"The market is obviously reacting to developments in France," said Emmanouil Karimalis, macro rates strategist at UBS.
"Still there is no clarity in terms of fiscal (policy), and we also had very negative PMIs yesterday," he said, referring to survey data that on Monday showed France's business activity unexpectedly contracted in September.
Investors have sharply increased the premium they demand to hold French debt compared with the country's eurozone peers since President Emmanuel Macron called a surprise election in June.
France's newly appointed Finance Minister Antoine Armand on Tuesday acknowledged concerns over his young age and lack of experience and said the country faced "one of the worst" public deficits in its modern history.
Armand confirmed new taxes on the wealthy and big businesses are on the table to get finances back in order.
"Apart from one or two one-off crisis years in the past 50 (years), we have one of the worst deficits in our history," the minister told broadcaster France Inter.
"On that level, the situation is grave."
Special treatment?
Barnier plans to present the 2025 budget to the French parliament and the European Commission by mid-October. A seven-year plan of reforms, investments, and debt reduction is expected a couple of weeks later, by the end of October.
In a Sunday interview, Barnier brought "targeted" tax rises on "wealthy people or some large companies" into play as part of a plan to right the ship.
While EU officials believe market pressure could put pressure on French politicians to make tough decisions, they fear a weak plan would undermine the credibility of the new EU fiscal framework that came into force in April.
"I don't expect that this time France will easily get away, this would be a major blow for the new rules," a third senior eurozone official said.
France has in the past enjoyed special treatment from the EU executive when it comes to compliance with EU fiscal rules.
The country has long fallen foul of EU rules requiring member states to keep budget deficits to less than 3% of economic output, and Paris has not booked a surplus since 1974, three years before President Emmanuel Macron was born.
Former commission head Jean-Claude Juncker once explained that the country got special treatment because "France is France."
The new rules – while allowing countries to negotiate their own debt reduction paths with the European Commission – are meant to show markets that EU governments are serious about reducing debt after the pandemic and the energy crisis.
"I guess the French plan will be a test case," a fourth eurozone official said.
"We'll see how much creativity there will be," he added, noting that even if the initial plan looks tough on submission, Paris could be granted leeway later, when the commission checks its implementation over the years.