France's Borrowing Costs Surge as Bond Market Pressure and Budget Deadlock Bite

France's borrowing costs have soared amid the country's worst social unrest in decades. Yields on French government bonds have climbed to their highest level in almost 25 years as investors demand bigger returns to hold French public debt. The move reflects a hardening view in the bond market that lending to France is becoming a riskier bet.

As France struggles with a widening gap between spending and revenue, its fragmented political landscape is deeply divided over how to close it. Hundreds of thousands of protesters, some of whom have taken part in rioting and looting, have taken to the streets against proposed budget cuts and are demanding more spending on cost-of-living support and public services such as education.

France's national debt now stands at its highest level since the immediate aftermath of World War II, approaching 120 percent of gross domestic product (GDP).

How do bonds work, and why are French borrowing costs rising?

A bond is a form of loan to a government or a company. Countries regularly borrow from the bond market to fund spending that is not covered by tax revenue. In return for buying a bond, investors receive regular interest payments plus the principal at a set date in the future. In the meantime, the bond can be traded on the bond market.

Bond prices are shaped by interest rates, inflation and confidence in the issuer's ability to repay, among other factors. When bond prices rise, yields fall, and vice versa.

Yields on France's 10-year bonds have risen by more than 130 basis points since June, topping 4.9 percent. French borrowing costs are now at their highest since 2002, taking an ever-larger share of the tax revenue that might otherwise go to essential services such as education and health care.

Although France's debt load is relatively high, the amount a country owes is only one of the factors investors weigh when pricing bond risk. Market confidence in a country's ability to meet its obligations is shaped by many things, including the strength of its economy, the share of foreign versus domestic debt, and whether its political system can govern effectively.

"The sustainability of public debt is rarely decided by its absolute level alone," Victor Lequillerier, president of the Paris-based BSI Economics research institute, told Al Jazeera. "It depends far more on its trajectory, its structure and the broader economic and financial context."

In France's case, the paralysis of its political system is now the key driver of bond-market anxiety. In a fragmented National Assembly, Prime Minister Sébastien Lecornu, appointed by President Emmanuel Macron under the semi-presidential system, is embroiled in a legislative battle to pass next year's budget with 54 billion euros ($61 billion) in savings.

Marine Le Pen of the far-right National Rally and Jean-Luc Mélenchon of the far-left France Unbowed, two leading contenders in next year's presidential election, both oppose Lecornu's proposals, even though the government could invoke a constitutional provision to bypass parliament if needed.

"Are France's numbers much worse than many other countries? No, but they are somewhat worse, and the real difficulty here is that the political situation leaves the current government with no easy path to a sensible budget in terms of debt sustainability," said Antonio Fatas, an economics professor at INSEAD in Fontainebleau, France. "That is what makes France a special case right now, and that is why markets are very worried about what France is going through."

What is France's fiscal position?

France's national debt stands at about 3.6 trillion euros ($4 trillion), equivalent to 119 percent of GDP, up from 98 percent in 2019, before the COVID-19 pandemic struck. But what worries markets more than the total debt is France's growing budget deficit, projected to reach 5.4 percent of GDP in 2026, far above the European Union average of just over 3 percent.

France, a country with a strong tradition of politics and left-wing activism, has long had one of the largest public sectors in the developed world. Government spending equals about 57 percent of GDP, second only to Finland among OECD countries. Public pensions make up a particularly large share of spending, at 14 percent of GDP, a figure likely to rise as the country's working-age population shrinks in the coming decades.

"Ironically, President Macron has long discussed the reforms needed to improve fiscal prospects and avoid attracting the ire of bond investors," Alex Dryden, a macroeconomist at the Centre for Sustainable Finance at SOAS University of London, told Al Jazeera. "Since 2017, Macron has talked about the need for pension reform to reduce the fiscal burden, but this is a politically sensitive issue in France and reform efforts have repeatedly stalled." Dryden added: "Addressing it would remove much of France's fiscal burden, but that is far easier said than done."

Although France levies some of the highest taxes of any country to sustain its large welfare state, its budget deficit widened sharply during the pandemic and has stayed above its recent historical trend since. Compounding the shortfall is a long stretch of weak growth: between 2000 and 2025, the French economy expanded at only 59 percent of the OECD average. GDP is forecast to grow just 0.4 percent this year, after 0.9 percent in 2025.

Lequillerier of BSI Economics said the French government has for years dodged the budget reforms that heavily indebted peers such as Italy, Spain and Portugal carried out to cut their deficits. "In the post-pandemic period, most European economies managed to normalize their fiscal positions and bring deficits close to sustainable levels. France did not, with sustained growth in public spending outpacing revenue growth," he said.

According to Lequillerier, investors' patience with governments that fail to exercise fiscal restraint has finally run out. "The adjustment is becoming more painful by the day, and France risks isolating itself within the euro area as its weakest fiscal member," he said.

Why is France under more pressure than countries with bigger debts?

Though relatively high, France's debt is still lower than that of several other economies, including the United States, Japan and Italy. But each of those cases has specific circumstances that mitigate the risk.

The US is better placed than its peers to manage a huge debt load because the dollar is the world's main reserve currency, allowing it to borrow relatively cheaply and in larger volumes. Japan can sustain a debt-to-GDP ratio above 200 percent because most of its debt is held by domestic institutions, shielding it from capital flight; its central bank also keeps interest rates extremely low. Italy has a debt-to-GDP ratio of 140 percent, higher than France's, but a smaller budget deficit of about 3 percent of GDP.

"How much debt a government can carry depends on quite a few factors and varies from country to country," Andrew Kenningham, chief Europe economist at Capital Economics, told Al Jazeera. "For example, investors will be more worried if a country's economy is growing slowly, or not at all, and if the government deficit is very high, meaning the debt ratio tends to rise. How much debt a country can carry also depends on who wants to buy that country's debt," he said.

According to Lequillerier, France is also under pressure partly because the bond market now offers investors more choices than before. "Germany is now running larger deficits and issuing significantly more debt, while Italy and Spain have strengthened their fiscal positions. As a result, France faces far tougher competition for international capital in the euro-denominated government bond market," he said.

Is France heading for a debt crisis?

According to economists, France's finances are far from unrecoverable, but the longer the government delays belt-tightening, the greater the risk of a full-blown debt crisis.

"What is the likelihood that France falls into a debt crisis? Enough for us to worry," said Fatas of INSEAD. "As an economist, I can say the numbers are not too bad. We can find a budget that puts France on a more sustainable footing, but that requires certain compromises and very, very difficult political choices in the current environment."

Lequillerier of BSI Economics argued that a French default is not a realistic prospect, but the country would suffer "a profound loss of economic credibility" if it had to seek support from an institution such as the European Central Bank (ECB) or the International Monetary Fund (IMF). "This is not the central scenario today. However, the longer fiscal adjustment is delayed, the less distant that outcome becomes," he said.