What Might The Scenarios Be For A French Debt Crisis?

Concerns are mounting over France’s debt: rising interest rates, a widening spread with Germany, soaring debt service costs, a massive budget deficit, political gridlock… All the indicators are in the red. Fair enough. But let’s try to look beyond the immediate situation and ask ourselves: What might a French debt crisis actually look like?

It is certainly not inevitable, but the likelihood of it happening is rising dangerously. We might as well consider the various scenarios so we can better prepare for them, should the need arise. Let’s imagine that interest rates on French debt skyrocket, that refinancing becomes increasingly difficult, and that investors turn away from it: what would happen?

Historically, when a country finds itself on the brink of default and wants to avoid total collapse, it can turn to the International Monetary Fund (IMF). The IMF then provides fresh capital in exchange for a severe austerity program and structural reforms. But since France is part of the eurozone, the European Central Bank (ECB) would also step in. This is, in fact, what happened during the Greek bailout in 2010–2012: the two institutions acted jointly.

However, its membership in the eurozone gives France a kind of deterrent — from the weak to the strong. Paris could say to the ECB: “Help me, because if I go bankrupt, the entire eurozone will collapse.” But France shouldn’t play that game too much, because the ECB could retort: “Fine, I won’t buy your debt. And in a few months, you won’t be able to finance civil servants’ salaries, social benefits, and pensions as usual.”

Is a bailout plan on the horizon? That’s unlikely, since it would require raising hundreds of billions of euros, which Germany and the well-managed countries would have to advance. The scale is, in fact, entirely different: Greece’s public debt stood at around 350 billion euros; France’s is ten times that, at more than 3.5 trillion euros. At best, one could count on a limited loan from the IMF.

Would a debt restructuring — in other words, a partial default — be conceivable, as was the case with Greece at the time, when private banks had to accept a write-down of more than 50 percent on their claims? Nothing could be less certain. Greek debt represented only a relatively small item on the balance sheets of major European banks; the situation is entirely different with French debt. A restructuring could trigger a domino effect and destabilize the entire European banking system.

And then it would be necessary to bail out French banks and insurance companies, which hold significant amounts of government debt on their balance sheets — but with what money? — while likely limiting bank withdrawals in the face of the inevitable panic that would grip part of the population. Finally, foreign investors — particularly those outside Europe — who would be harmed by this haircut might turn away from French debt, or even more broadly from euro-denominated assets. This is a threat that eurozone countries would seek to avoid at all costs.

Neither a massive bailout nor a restructuring: the adjustment would then likely take place in two ways. Internally, through an austerity plan of a severity never before seen in France; externally, through the ECB’s printing press, which would buy up part of the French debt that no one would want anymore. The two would certainly go hand in hand. There would be no question of simply monetizing the debt to allow the government to continue spending without consequence: Germany, as well as other European countries fed up with France’s fiscal laxity, would pressure the ECB to demand significant concessions in return.

We would no longer be talking about indexing pensions, but potentially about cuts of 20 or 30 percent, and likely comparable measures affecting civil servants’ salaries and certain social benefits — to which would be added a sharp increase in the VAT and various other taxes and levies. A levy on savings, possibly presented as a “mandatory loan,” could also be considered: this would be the “innovation” compared to the Greek case, as the government would have an immediate need for fresh funds. The government would no doubt promise to “make up for it once the situation improves.” Few people would believe it.

A massive privatization program would also be launched. This isn’t necessarily a bad thing in itself, but the rush would lead to assets being sold off at bargain prices. The recessionary impact of all these measures would be considerable, and GDP would plummet.

In short, the situation would be worse than that of Greece, which had benefited from massive bailout packages — about 100 billion euros, or roughly one-third of its debt — and yet still saw its GDP collapse. For France, the medicine would be particularly bitter. And the financial and economic crisis would immediately turn into a major political crisis, the outcome of which would be very difficult to predict…