During months, economists and commentators alerted us to the risks on financial stability generated by too low or even negative interest rates. Donald Trump election has encouraged financial markets to anticipate a switch of American economic policy: monetary policy would become more restrictive, and the first signal should come next week with an interest rate rise decided by the Federal Reserve Board, while the budgetary policy would become more expansionist through taxes reductions and the launch of a public investments program. Actually, if the first part of this change is granted, the second one is more uncertain. The impact on interest rates of this new economic context, to which it should be added the political uncertainties in Italy, has been immediate worldwide. In the U.S. and in England, long term rates have increased by about 100 basis points. In Europe the rise has been more modest, with about 50 basis points, but it has been interpreted as a break after the brutal and deep fall which has characterized the last two years. In France, 10 years OAT which, during the last six months, offered a return of about 0,40% has risen to 0,80%. This level is still very low since we should remember that between 2012 and 2014, France was borrowing for these maturities with an interest rate between 2 and 3% and that during the years 2000, we were near 5%.
These prospects have generated a new wave of alarmist comments. We could have expected that the risks associated with too low rates having disappeared, their rebound would have been welcomed. It is not the case and no occasion is lost to emphasize the risks for states of an increase of the burden of their debt. In France, political leaders belonging to the opposition, who have by a large amount contributed to the increase of the public debt between 2002 and 2012, are holding up the threat of a default. The argument is even shared, more moderately, by an eminent French member of the management Board of the European Central Bank. It is anyway rather a paradox since the institution has just announced it was keeping its interest rate at 0% and extending until the end of 2017 its public and private bonds purchasing program. Even if the size of the purchases will be slightly reduced from April 2017, this decision reflects the strong will to go on with an expansionist monetary policy, which means that interest rates will stay, at least during more than a year, at very low levels.
All these comments misjudge, knowingly or not, the two characteristics of French public debt: it has a long maturity and fixed interest rates, with a very small portion of indexed bonds. A rise of mid and long term interest rates has no consequences during the issuance year because the first interests will be paid the following one. Each new issuance is used to finance the increase of public debt for about one third and to reimburse bonds arriving at maturity for two third. But the bonds arriving at maturity are carrying interest rates much higher. For instance, this year, in October, the State has reimbursed a 26 billion euro loan carrying a 5% interest rate. It cost to it every year 1.3 billion. The average rate of French issuances since the beginning of the year has been around 0.4%.The interest France will pay in the future through bonds issued to finance the reimbursement of this 5% bond will be ten times cheaper and the State will save every year about one billion. The same phenomenon will happen again in 2017. Next October, a 35 billion loan carrying a 4.25% interest rate will come at maturity, costing every year almost 1.5 billion. If long term interest rates are, then, 1.25%, according to Bercy forecasts, which would mean a substantial rise that, in fact, nothing allows us to suppose, the annual gain, from 2018, will be 1.5 billion, which must be added to the billion saved in 2017. These two examples show well how the structure of the French public debt is going to change. During next years, the dominant factor will be the redemption of an old debt carrying very high interest rates and its substitution by bonds issued in a very different European context, even if it is a little less favorable than during the exceptional period we have known since the beginning of this year. And this factor will, by far, compensate the consequences of the increase of the debt due to future budget deficits.
Unlike we are told, the cost of the French debt, in the future, will diminish. The magnitude of this diminution will however vary and depend of the continuation of the current policy regarding issuances premiums which consists in proposing to investors bonds carrying interest rates superiors to market ones. In subscribing to them, they pay, in advance, the surplus of the interests they will receive until the bond comes at maturity. Last December 1st, France has issued a 25 years bond carrying a 4.5% interest rate, for, indeed a modest amount of 1,8 billion. But it received a 1.2 billion premium equal to the difference, all along the life of the bond, between the market rate at the time of the issuance, which was near 0.8%, and the interest which will be paid during 25 years. This practice, criticized by “Cour des Comptes”, is not new and was followed in the past at a very low level until the financial crisis. Then, it rose, as an average, to 5 billion until 2014. But, in 2015, it exploded to reach 25 billion and this record will be broken in 2016. It is quite atypical and the amounts collected by France, through that practice are twice higher than the eurozone average. On the opposite, Germany doesn’t use it, which gives us the proof that the arguments developed by the French Treasury Agency, as an answer to “Cour des Comptes”, are irrelevant. More, issuances premiums (above 1% of GDP in 2015 and 2016), are not taken into account to calculate the budget deficit of the issuance year but the artificially high interest rates paid the following years will be included in their deficits. The resources generated by the premiums are used to reduce short term borrowing needs and the amount of the public debt. But the benefit of these resources is especially low since during 2016 and it will continue during 2017, due to ECB policy, short term borrowing costs are and will stay negative. So, the State is inflicting to itself a double punition.
There are no reasons, before a very long time, for seeing an increase of the burden of the public debt in France, even if there is a significant rise of long term interest rates, which is highly unlikely due to the decisions ECB announced this week. During the next five years, there are more than 300 billion in long term bonds which will come at maturity and which will be refinanced with rates two or three times lower, which will be enough to cover the impact of a possible rate rise. Our political leaders, instead of holding up groundless threats, should do better to get informed about financing practices chosen by the administration and on the credibility of budget numbers. It would prevent them from delivering gloomy messages which contribute to weaken our economy.