France is in the midst of its most significant social unrest in many years, with protests initially centred around lack of education reforms and underfunded schools, before broadening out to wider dissatisfaction over cost of living, high fuel costs and deteriorating public finances. Amidst episodes of sporadic rioting, the government imposed localised overnight curfews to bring the situation under control. The timing of the protests is sensitive as the authorities seek to advance a 2027 budget. The proposed consolidation not only assumes lower spending on controversial areas including welfare, state-sector wages, pensions, but also imposes a higher tax burden. The math also rests on an optimistic growth assumption of 1.0% in 2027, vs sub-0.5% forecast this year. A delay in budget rationalisation efforts could push public debt to GDP ratio above 120% of GDP. In the wake of the 2018 yellow vest protests, Banque de France had halved its growth projection for 4Q18, while Finance Minister Maire had projected ~0.1ppt hurt to annual growth, amid already slowing growth momentum. This year, if signs of disruption persist (unions have called for more protests towards late-Oct and early-Nov), a broader loss of confidence could entail a bigger economic price through lower consumer spending, damage to tourism and logistics.
For the markets, the main channels of transmission are widening bond spreads, a higher sovereign risk premium, and likely cautious commentary on sovereign ratings. The unrest has added another layer of uncertainty to pre-existing political and budgetary worries. French OAT – Bund spreads have rewidened to more than ~150bp, while domestic equities have corrected sharply. The pass-through via higher financing costs is a pertinent risk. The euro had initially lost ground, but counter-vailing factors limited the correction. In the face of fierce opposition, there is a concern that fiscal consolidation measures might be watered down and social spending might be increased to ease tensions. Far-right candidates are in the lead for the upcoming elections, but their policy proposals are set to hit operational and funding constraints. France is increasingly trading in a high-fiscal-risk, low-growth, weak-political-capacity loop, which is likely to keep bond yields high and pose a risk to the euro in case of spillovers to other member countries. As we had highlighted earlier, a swift response from the ECB is not on the cards, given the localised nature of these challenges.
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