Political deadlock in France - where does the country go now?

The final round of voting in the French national elections has left the country in a state of limbo, with none of the main parties {the far-right National Rally (RN), the left-wing alliance New Popular Front (NFP) and the centrist Ensemble (EN)} securing a majority of seats in the French Parliament. And with each of them pursuing largely incompatible political philosophies, forming any kind of administrative coalition going forward will be difficult.

Markets have breathed a sigh of relief

The initial reaction of the markets has been to breathe a sigh of relief, given that the feared RN victory did not come to pass, the party ultimately coming third. The opinion polls clearly got this election wrong, with the feared ground-swelling of far-right extremism being rejected, for now at least. However, despite being clearly disappointed at not securing the forecast majority in parliament, the RN will privately be pleased that it has roughly doubled its number of parliamentary seats. And it may well be that what cost it victory in the end was the relative inexperience of its candidates, who failed to get across the party’s message clearly enough to assuage concerns about its anti-immigration foundations, an issue that is sure to be addressed in time for the next election. But with none of the other parties willing to work with RN, the prospect of an RN-led government is off the agenda this time around.

But there are not only fears about a far-right government

However, if the markets are relieved about RN coming third, the prospect of a government led by the NFP will be equally worrying. Coming first in the election, NFP is a coalition of left-of-centre and far-left smaller parties, typically at loggerheads with each other, but who came together to prevent RN from winning. The NFP leader, Melenchon, is very much the left-wing radical who has said that, if in power, would run an interventionist government that would, among other things, reverse Macron’s pension reforms and embark on a programme of wealth distribution through increased spending and higher taxes for the better-off. His plans would certainly run up against the EU’s fiscal responsibility rules and quickly see an EU/France battle ensue. And unfortunately, the other parties in the French Parliament, such as the greens, the socialists and the communists, all signed up to this NFP policy agenda under Melenchon when the party was formed three weeks ago to block RN.

Next stage now in the hands of Macron

The next stage is for French President Macron to appoint a new Prime Minister (PM), albeit there is no constitutional deadline in which this must be done. A confirmation vote of his ultimate choice is not required but in practice will take place, given that a PM needs to be backed by a majority in parliament given its ability to take down the government through a vote of no confidence. And here the difficulties begin. The choice of a PM from his own party, EN, or from RN, will not be supported by either of the other two parties, which means the new PM will likely come from a member of NFP, leaving France with a ‘co-habitation’ government (ie when the Presidente and PM come from different parties). However, given the split nature of the NFP, it will be equally difficult to find a leader in the alliance who will garner enough support to form a working government either. With the RN certain to be unsupportive of any proposed candidate, an NFP leader such as Melenchon is unlikely to see the support of the EN party either, while if Macron chooses a more centre-left candidate, they will almost certainly lose the support of the far-left elements of NFP and similarly face not having a majority.

The French fiscal position is a big headache

One of the key considerations Macron will need to take into account when choosing a new PM is the 2025 budget, which is rapidly coming into focus. The French fiscal position is coming under the increasing scrutiny of both the markets and the EU, given the country’s recent rating downgrade by S&P, while it will also need to abide by the restrictions of the EU’s Stability and Growth Pact and the new EU fiscal framework. With a current budget deficit of 5.5% GDP last year and the EU expecting it to fall to just 5.3% this year, the EU proposed last month that France be placed under an Excessive Deficit Procedure, which if approved means the new government will have to implement a fiscal consolidation of at least 0.5% of GDP each year. Plus, from 2025 onwards, the new fiscal framework will apply, which aims to put the debt ratio (currently 111% GDP) on a downward path over the medium term and which will certainly require additional multi-year fiscal consolidation. It is highly unlikely that any PM appointed from the NFP will agree to these spending restrictions, given that it is committed to measures such as lowering the retirement age back to 60 years, expanding public spending by Eur150bn, raising the minimum wage by 14%, restore wealth taxes and increase the progressivity of income taxes, and provide subsidised funding for small- and medium-sized enterprises. Macron is very much faced with a Hobson's choice of a politically unacceptable but more economically prudent RN, or an economically unacceptable but more politically prudent NFP.

The medium-term casualty is likely to be the euro

It looks set to be a long and tortuous road that France will now be embarking on to find a new PM. The only certainty at this stage is that the PM will not come from RN, given the unwillingness of any other party to collaborate with them. A centre-left coalition of EN and the more market-friendly members of the NFP alliance could be possible and would likely be well-received by the markets. But on the other hand - and just as likely - is that the NFP remains united and refuses to break up just to collaborate with the more centrist EN, suggesting a lengthy period of political uncertainty. But even if some kind of EN/NFP alliance is possible, EN would almost certainly need to compromise with the ‘left’ on some areas of economic policy, which the markets might find problematic, given the need to square France’s budget with the EU’s demands.

Accordingly, whatever the outcome and whatever path France ultimately takes, the outlook for the euro is looking more troubling than it did just a couple of weeks ago.