Britain risks following France into a terrifying debt crisis

Telegraph

27-07-2025

Last week brought more bad news about the UK's public finances.
June's figures for public sector borrowing came in at £20.7bn, well above the OBR's forecast and City expectations.
What's more, £16.4bn of this was accounted for by debt interest payments.
Yes, that's right: £16.4bn in one month. We are borrowing enormous sums to pay the interest on past borrowings of enormous sums. We are getting dangerously close to what economists call 'the debt trap'.
This is when, under the pressure of rising debt interest payments, the debt ratio starts to explode. It goes without saying that it is good to avoid this, if you can. But can we?
Be warned, you may need a ready supply of hot towels for this next bit.
The key players in the debt drama are: the budget deficit, the debt ratio, the growth rate of the economy in money terms (which is equal to the real growth rate plus the rate of inflation) and the rate at which the Government can borrow.
If the rate at which the Government borrows exceeds the growth of the economy (in nominal terms), then debt interest payments and the overall debt will rise as a share of GDP.
In order to stop this process from leading to an ever-higher debt ratio, the Government must run a primary budget surplus (meaning a surplus on its budget without interest payments), requiring higher taxes and/or cuts in government spending. And the higher the initial debt ratio, the larger the surplus needs to be to stabilise the debt ratio.
The debt dynamics are merciless. When emerging market countries become stuck in the debt trap, the result is usually default or much higher inflation, or both.
Remarkably, given our pitifully low to non-existent real growth rate, the nominal growth of GDP (i.e. expressed in money terms), exceeds the average rate at which the Government borrows by a small margin. Phew!
But this is somewhat misleading because the average cost of government debt is heavily influenced by past borrowing, some of which was at lower interest rates. When this debt matures, there is a risk that it will be refinanced at higher interest rates.
So we are currently just avoiding the debt trap, but with the deficit so large, the debt ratio is still rising.
In these circumstances, it is hardly surprising that the gloom is still gathering about the fiscal prospects that the Chancellor faces in the Budget this autumn. It hardly makes our position any better, but we are not alone. Amid all this domestic pessimism, few people have noticed what is happening to our close neighbour across the channel.
France is facing a fiscal predicament every bit as serious as ours. For a start, France's ratio of government debt to GDP is higher than ours – 113pc of GDP compared with our 100pc. And its deficit is higher too – 5.8pc last year compared to our 5.1pc.
And ours is set to be just under 4pc this year. In both countries, GDP growth has been weak, and prospects are clouded with uncertainty.
The one area where France is better positioned is the cost of borrowing, and this really does show the weakness of the UK's position. Whereas 10-year bond yields here are 4.6pc, in France they stand at about 3.5pc, similar to other euro-zone members.
In this regard, however, something extraordinary has been happening. French yields have been converging on Italy's.
The gap between them is now only 0.18pc, the lowest for almost 20 years. It doesn't seem too fanciful to imagine that French yields will soon surpass Italy's.
Admittedly, after a recent period of comparatively strong growth, it looks as though Italian economic growth is set to be slower than growth in France, returning to the long-established norm.
That certainly does not make the job of stabilising the public finances any easier. And, at 135pc of GDP, Italy's debt ratio is a good deal higher than in France.
But Italy possesses two striking advantages. First, its fiscal deficit is only 3.4pc of GDP, compared to France's 5.8pc. And excluding interest payments (the so-called primary budget), it is in a surplus of 0.5pc, compared to France's deficit of 3.7pc.
The result is that to stabilise the debt ratio, Italy needs to tighten the budget deficit (through a mixture of higher taxes and expenditure cuts) by only 0.5pc of GDP. By contrast, to stabilise her debt ratio, France needs to tighten fiscal policy by over 3pc of GDP by 2027.
Italy's second advantage is surprising to anyone who has followed Italian politics over the past 80 years. She seems to be more politically stable than France.
Giorgia Meloni looks likely to be Italy's first post-war prime minister to complete their term. In France, there have been six prime ministers since 2020, and the current incumbent, Francois Bayrou, who heads a minority government, could be ousted any time soon.
He recently announced a plan to tighten French fiscal policy by 1.5pc of GDP. By comparison, Rachel Reeves' Budget last October increased taxes by 1.2pc of GDP, but this was more than offset by increases in public expenditure.
There is little chance of the proposed French tightening getting through parliament unscathed. The failure to pass a budget for next year, leading to the fall of the present government, could cause French bond yields to flare up.
And then there is the presidential election in 2027. On voting intentions in the first round, Jordan Bardella, the likely candidate of Marine Le Pen's National Rally, is well ahead of the other candidates.
Obviously, there's many a slip twixt the cup and the lip. But if the markets were to view a victory for the National Rally as likely, then they would surely send French bond yields much higher, thereby putting France in a dangerous fiscal position.
We cannot gloat. There but for the grace of God go all of us.