France’s Fiscal Compact Hindsight

“C’est moi?” Source: Getty Images Europe.

It seems France may miss its EU-imposed budget deficit limit of 3% of GDP this year. (We imagine the Greeks are feeling the tiniest bit of Schadenfreude.) The country’s deficit is now forecast at 3.6% of GDP, up from a prior estimate of 3.5%. However, this isn’t much of a surprise, given France’s economy has been contracting slightly.

Historically, countries missing the target have been dealt little more than a scolding from the European Commission (EC). However, France ratified the European Fiscal Compact last November (which went into force January 1, 2013), meaning the country will have a little more accountability. But even under the Fiscal Compact, France will still have a year to bring its budget deficit into compliance—which means cutting spending further or finding more sources of revenue. (Might we suggest looking into the economic competitiveness issue to boost growth and thereby revenue?) Yet even if France continues to miss its budget deficit target after a year, the country merely gets put on “probation.” From there, it must endure the EC’s prescriptions for gradual improvement targets.

At worst, the country could be fined 0.1% of GDP if it fails altogether to address the issue to the EC’s satisfaction. However, we’ll be ever so curious to see if this fine survives. We have to guess France never imagined it would be on the receiving end of such a fine. (C’est moi?) And it may find reason to push back on the legality of the fee, as well as the method of collection, where the fee might go, etc. After all, if a nation has a deficit, it seems an odd punishment to force it to hand over still more cash, contributing further to said troublesome deficit.

What’s most important for France right now is it continues to be able to issue debt at relatively reasonable rates with ample demand. An early February auction of benchmark bonds showed yields at 2.30%. This was higher than January’s auction rate of 2.07%, but still enviously low. Even following a weak PMI data release on Thursday, benchmark rates on French bonds fell five basis points to 2.23%. Although rates could certainly go up from here should France’s situation deteriorate considerably, that its debt continues to be quite affordable by European measures likely underlines the market’s continuing confidence in France.

Now, access to debt markets at reasonable rates is far from a guarantee all is well. Rather, for France right now, it’s an indication it’s not likely the eurozone domino that falls next. From here, we hope France uses this as a wake-up call to give close examination to many of its own economic policies and to make the adjustments necessary to bring it out of its current slump. But if it doesn’t, it could find itself on the receiving end of its own fiscal stick.