France's newly installed government presented a draft budget on Thursday that includes 60 billion euros ($65.6 billion) in tax hikes and spending cuts, as analysts warned the package may not be enough to prevent economic rating downgrades.
The 2025 budget puts a stronger focus on tax-raising measures than some had expected. Analysts also pointed to “politically complicated” proposals, such as delaying inflation adjustment for pensions and cuts to local government, public services and the health system.
Other important elements include temporary additional taxes for large shipping companies and corporations with an annual turnover of more than one billion euros, which affect around 440 companies; an income tax surcharge for households with incomes over 500,000 euros; the reintroduction of a levy on electricity consumption; and an increase in taxes and fees on airline tickets and high-emitting cars.
One of the budget's main goals is to cut France's projected deficit of 6.1% for 2024 to 5% of gross domestic product next year – an attempt to comply with European Union rules that state a member state's budget deficit should be 3%. of GDP should not exceed.
The government set a new target to meet that rule by 2029, an expansion of its previous target of 2027. It also warned that without action, the deficit could rise to 7% next year.
Political challenge
The task of raising 60 billion euros in a year left the government with few options, meaning it had to turn to “politically complicated” options, Hadrien Camatte, senior economist for France, Belgium and the euro zone at Natixis, told reporters CNBC. Squawk Box Europe” on Friday.
The fragile French government under Prime Minister Michel Barnier already had to face a vote of no confidence this week, which it survived.
The government was formed last month after difficult negotiations following July's general election, in which the left-wing New Popular Front – itself a relatively divided alliance – won the most seats but gave no party or coalition a majority.
Barnier acknowledged this, calling the budget proposal a starting point for lawmakers' debate and saying he was open to changes that preserve financial integrity.
“There will be changes and there will be a heated debate about pensions and social security contributions,” Camatte said. Debate on the budget is scheduled to begin on October 21st and various parts of it will be voted on from October 29th.
“The problem is when you have to find 60 billion. We have never found 60 billion in one year, that would be unprecedented, and so finding such a large amount is not very credible, especially with only a very fragile relative majority.”
Tax focus
The policy mix underlying the 2025 budget is “less focused on spending cuts and more focused on tax increases than we expected,” analysts at Goldman Sachs said in a note Friday.
“The scale of the proposed consolidation and the associated reliance on tax increases make us less confident that the government can meet its 2025 deficit target of 5.0%. Our previous research has shown that “abrupt adjustments and tax-based consolidations tend to have a lower chance of sustainably improving the fiscal position,” they wrote, pointing out that their own deficit forecast was 5.2%.
However, they also pointed to the potential for short-term political stability as the government survives the October 8 no-confidence vote.
French Minister of Economy, Finance and Industry Antoine Armand arrives at the Elysee presidential palace to attend the weekly cabinet meeting presenting the 2025 French budget in Paris, October 10, 2024.
Ludovic Marin | Afp | Getty Images
That means their base case currently is for the government to pass the draft budget by the end of the year, they said, but with greater uncertainty beyond that point.
“If you need fresh money very quickly, you have no choice but to increase taxes. The problem is that taxes in France are already very high,” Natixis’ Camatte told CNBC, pointing out that the country has the second highest wage tax rate in Europe.
Although the focus is on tax increases, the bill's split is expected to result in a 40 billion euro cut in government spending and a 20 billion euro increase in revenue, according to Erik-Jan van Harn, senior macro strategist at Rabobank.
However, he added: “Barnier's ambitious plans pose implementation risks. His government is committed to 2029 but is unlikely to survive until then.”
Rating risk
Questions remain about what the 2025 budget will mean for France's economic growth and whether the country can avoid further downgrades of its sovereign debt rating after cuts by the S&P and Fitch agencies over the past two years.
The government has expanded its measures to avoid hurting economic growth, Evelyn Herrmann, European economist at Bank of America Global Research, told CNBC's “Squawk Box Europe” on Friday.
“The hope is that by doing this, and perhaps by targeting more the upper income groups and the particularly profitable companies – and promising to do that temporarily – you might avoid a kind of typical strong effect of these measures on growth,” she continued continued.
However, Goldman Sachs analysts estimate that the impact of the package on economic growth will be from an increase of 0.3 percentage points in 2024 to a decrease of 0.5 percentage points in 2025 and 2026; while UBS said historically high fiscal consolidation of 2% of GDP would “likely weigh on growth”.
Statistics agency Insee this week forecast 1.1% growth for the French economy this year, which Natixis' Camatte called “perhaps a little too optimistic, although it is not unrealistic.”
“I am worried about the development after 2025 because measures to reduce the deficit after 2025 are not documented and if you do a debt sustainability analysis, France's development clearly represents a risk,” he said.
In the short term, rating agencies will be in a wait-and-see stance due to a lack of concrete details on the budget, he added, although a negative outlook from S&P or Fitch cannot be ruled out.
“At this point it is important to remain calm and decide next year whether the spending cuts are credible or not,” said Camatte. However, he expects Moody's, which has maintained a better rating for France, to give a negative outlook this year and downgrade next year.
Rabobank's Van Harn was even more pessimistic, arguing that sharp spending cuts would “slow economic growth” and that “a rating downgrade by one of the major rating agencies appears likely.”
“Severe austerity measures come at a price. Already weak economic growth is being hit by a dramatic shift in France's fiscal stance. The government would do well to consider the economic side effects of its policies, but the lack of political capital risks doing so.” “Barnier will be forced to make the wrong decisions,” he said on Friday.
“Given the risks already highlighted [Fitch] and the comparatively optimistic nature of its previous forecasts, we believe a downgrade of the rating is likely. While this is clearly not positive from a spread perspective, we believe the market is already largely pricing in such a move.”
—CNBC's Charlotte Reed contributed to this story
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