Unrest in Paris: Could France Pose a Threat to the Eurozone?

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In a surprising turn of events, Prime Minister François Bayrou has failed a vote of confidence in parliament, marking the collapse of France's centre-right government after barely nine months. This political stalemate in France could have serious consequences for the Eurozone, as the country grapples with a high and rising public debt, expensive new borrowing costs due to political instability, and severe challenges in implementing fiscal reforms and stimulating growth.

According to Joachim Schallmayer, head of capital markets and strategy at DekaBank, this failed vote of confidence marks the provisional end of a development that confirms France's reform incapability. The economic situation in France after the government's fall is concerning, with France having the third-highest debt ratio in the EU at 114 percent. In absolute terms, France has the highest debt pile in the Eurozone at around 3.3 trillion euros.

The budget deficit in France was last at 5.8 percent. Goldman Sachs estimates that the greatest economic challenge for France is to stabilize public debt. The investment bank urges France to resume reforms to boost growth. State spending in France is among the highest in Europe.

New debt for France is becoming increasingly expensive due to political crises and lack of austerity measures. The yields on French government bonds have risen significantly more than in Italy, and the yield on ten-year French government bonds is now barely below the Italian level. Economist Gitzel believes that the ECB could provide support purchases if the risk premium on French government bonds continues to rise significantly.

The European Central Bank (ECB) has the "Transmission Protection Instrument" (TPI) at its disposal, which would allow the ECB to buy bonds of individual Eurozone countries in unlimited quantities in a crisis. ECB President Christine Lagarde expects the French banking system to be better positioned than during the last financial crisis and does not expect France to request help from the International Monetary Fund (IMF) to stabilize its finances.

However, the situation in Paris may occupy the central bank more, as after the ECB's interest rate decision this Thursday, Lagarde will have to answer questions about France. Berenberg economist Felix Schmidt explains that the TPI is intended to protect countries that are exposed to unjustified market attacks and not those that make poor fiscal decisions. Thomas Gitzel, chief economist at Liechtenstein's VP Bank, believes that a budget consolidation in France will not succeed until the next presidential elections in 2027 due to the fragmented political landscape.

The political crisis in France underscores the need for reform and fiscal responsibility in the Eurozone. As the situation unfolds, the ECB and other European institutions will need to closely monitor the developments in France and consider their implications for the broader Eurozone economy.