Political developments and financial issues in the eurozone’s second-largest economy, France, threaten to bring a new debt crisis to the bloc.

France is experiencing a historic period of deepening fiscal indiscipline, political turmoil and protests all at the same time.

The country’s public finances deteriorated and pushed its borrowing costs to their highest levels in recent years, while the euro depreciated against the US dollar, falling to 1.116, marking its lowest level in about a year and a half.

Economists are uncertain whether this trend, starting in Paris and rapidly spreading, will engulf the rest of the eurozone in a new debt crisis.

France’s public deficit reached 5.8% of its gross domestic product, above the EU’s 3% threshold, while the country aims to reduce this deficit to 5% by next year, according to the French National Institute of Statistics and Economic Studies.

France has not posted a budget surplus since 1974, and public spending has risen despite slow growth in tax revenues.

More than half of the €1.3 trillion ($1.5 trillion) added to the debt since 2017 stemmed from COVID-19 and energy-related spending, while the rest was due to tax cuts for households and businesses.

The country’s total public debt-to-GDP ratio is expected to reach 121.7% by 2027 as a result of these chronic budget deficits.

France’s nominal debt stock hit its highest level since 1945 at €3.6 trillion ($4 trillion), equivalent to 119% of GDP.

Analysts say France fell into a structural debt trap in which nominal growth rates remain below borrowing interest rates, while the country’s public debt-to-GDP ratio twice exceeded the 60% Maastricht criterion.

The current situation of the French economy fuels concerns about contagion risk due to budget deficits in the European bond market, while the selling pressure facing Paris has already begun to spread to other eurozone countries like Italy, Belgium and Greece, experts note.

Paris is prompted to borrow from the markets every year due to the structural gap between France’s public revenues and spending, which affects borrowing costs, driving them up to around 4.5% from near 0% in 2020, as investors lose confidence amid broader global monetary tightening to combat inflation.

France’s annual interest payments are expected to reach around 7% of the budget, or as high as €65 billion ($73 billion). The interest burden is growing to become the single largest spending item in the country’s budget for the first time in history, exceeding even spending on elementary and secondary school education.

Prime Minister Sebastien Lecornu’s minority government prepared a radical €54 billion ($60.6 billion) package to gradually reduce the budget deficit to 5% by next year, but this program faced massive public resistance in street protests.

Firefighters and public sector workers protested the budget cuts, while high school and university students took to the streets in protest.

For days, protesters have been demanding an end to the long-standing shortage of teachers, inadequate education conditions and a lack of physical infrastructure. High school students barricaded their schools while demanding more funding for education.

The police used pepper spray and rubber bullets against protesting students, sparking a backlash from the opposition.

Some 170 students, 65 education staff members and over 600 law enforcement officers have been injured in the protests, while legal proceedings have been launched against more than 5,000 people. Some 400 high schools suspended in-person classes, accounting for around 10% of all high schools in the country.

Meanwhile, France’s inflation continues to erode purchasing power, as its EU-compliant annual inflation rate surged from 2.6% to 3.4% in September due to rising oil and natural gas prices amid the Middle East conflict. Energy prices in France rose 2.1% on an annual basis in September, driving the broader rise in inflation.

The yellow vest movement, organizing due to price hikes, demands not only an increase in the education budget but also a freeze on energy prices and additional taxes on large corporations.

With President Emmanuel Macron’s term nearing its end, opposition parties are resisting unpopular budget cuts in parliament.

Paris’ efforts to pass the budget without a parliamentary majority continue to drag the country deeper into a political crisis.

The crisis is affecting the euro, as the region’s currency started the week with a sharp decline, testing below the psychological threshold of $1.12.

Growing concerns over Paris’ public finances, the widening interest rate difference between the US and Europe and surging oil prices contributed to the decline.

Thu Lan Nguyen, head of foreign exchange and commodity research at Commerzbank, stated that while the euro remained largely unaffected by the bond market’s volatility in recent months, these concerns are no longer limited to France and are taking center stage among investors.

The unease in the bond market affects the risk premiums of other countries, as the yield spread between French and German 10-year bonds widened by 32 basis points to 141 last week, while nearing 150 basis points on Monday, the largest weekly widening since 1990.

James Smith, developed markets economist at ING, recently said that France is facing a major impasse in reducing its budget deficit below the 6% threshold amid a fragmented political structure.

The minority government’s new budget plan would not bring lasting relief to the bond markets, according to a joint analysis by ING.

Deutsche Bank’s Jim Reid said the real question hinges on whether these developments mark the beginning of a new euro debt crisis or whether the markets are simply overreacting to the turmoil.