These last three years, France, as the other developed countries, has been confronted with three major shocks, the corona virus pandemic, the invasion of Ukraine by Russia which has provoked a strong fossil fuels prices increase and the disorganization of the supply chains especially from China, a direct consequence of the sanitary crisis. To remedy to it, the State has adopted costly support measures which have increased an already high budget deficit. These different shocks have revived inflation, a phenomenon which had practically disappeared for near forty years at a time when public indebtedness knew an important augmentation.
That simultaneous apparition of inflation and of an increase of the public debt, could, at a first sight, seem to be reassuring because less than 10% of that debt is indexed and the interest rates remained by large inferior to the prices augmentation. According to the last published figures, prices increase has reached 5.2% in France and 8.1% in the euro zone. The rate of the State 10 Years bond was 1.81% on June 7th, its highest level for four years but still by large lower than inflation. The financial markets are taking into consideration the end of the ultra-accommodative policy of the European Central Bank which will stop its net buying of bonds on the market and in the coming months will increase its interest rates.
In Europe and strangely in Germany, inflation, above 8%, is much stronger than in France. But that has not impeached investors to show they were less attracted by the French debt because the spread for the 10 Years maturity is now superior to 50 basis points. The main reason is the high level of the French public indebtedness. It has reached 114% of the GDP against 71% on the other side of the Rhine. For the French State, due to the supporting measures adopted to limit the effects of the pandemic and of the energy prices increase, the negociable debt exposure has come from the end of 2019 to the end of April 2022 from 1823 to 2189 billion euro, i.e. an increase by 366 billion.
That simultaneous increase of the debt exposure and of the interest rates has not have yet consequences on the amount of the paid interests by the State because these ones are fixed. It was forecast in 2018 that this charge would overpass 45 billion but it will be in 2022 only 36 billion. The redemption of the loans issued in the past and carrying high interest rates and their refinancing with bonds having very low rates is at the origin of this diminution, despite the strong growth of the indebtedness.
The consequences of the irruption of inflation in a context of a high indebtedness are double. The first one is about its positive impact on the State receipts. They are significant during the first four months of the year. When growth has slightly fallen (-0.2%) during the 1st quarter, the tax revenues coming into the coffers of the State show an increase by near 15 billion euro, if we don’t take into account the 7.4 billion received from Brussels rebound plan. The profit tax on enterprises has already brought 2 more billion and the VAT 6.3 billion, i.e. a 12% increase of the receipts. Regarding income tax, it has brought 2 billion more than last year, i.e. a 7% increase.
So the expected receipts will grow strongly faster than the interests charges but when the share of the bonds carrying higher rates in the total debt will increase, this effect will disappear. So, mechanically, during a first period, the interest charge compared to the GDP will diminish because this one, in value will grow faster, thanks to inflation. We have the same effect on the indebtedness ratio, which will allow the government to support its policy and to pretend that this one doesn’t put the country financial situation in danger. But these indicators do not give a full vision of the reality due to the presence inside the debt of bonds indexed on French inflation or, which is much more worrying, on the European one.
The amount of the State indexed debt has increased between the end of 2019 and April 2022 from 226 to 252 billion. The indexation charges are not included in the annual accounts but only when the bond comes at maturity. So, on 2022 July 25th, comes at maturity a loan carrying a 1.1% interest indexed on the euro zone inflation. Its amount is near 20 billion. But the sum to be reimbursed will be near 24 billion. So the charge created by the indexation for the State budget will be superior to 4 billion. The phenomenon will be reproduced in July 2023, when another bond, this time only indexed on the French inflation, will come at maturity. The indexation charge will also be over 4 billion. In 2024 and 2025, the consequences of indexation will be lower because the size of bonds coming at maturity will be smaller.
These risks, during an inflationist period, have not yet dissuaded the State to continuing to create bonds having apparently a low cost, because they still carry very low rates, when these ones have strongly increased on the financial markets, but which include an indexation clause, which is, itself, very costly on the long term. It is then, in June, that a “green bond” indexed on the euro zone inflation has just been issued with a 2038 maturity and a 0.1% rate. The State has risen 4 billion but the investors demand had reached 27 billion. So it is the proof that the subscribers are the main benefactors of that kind of financial product which protect them against the inflationist risk.
The analysis according to which inflation profits to the one which is indebted because the amount to be reimbursed is fix when receipts are increasing must be nuanced in the case of the State. Facing the prices rises, the European Central Bank, to remedy to it and in conformity with its mandate, will have to increase its interest rates, which will be transferred to financial markets and which will make more costly the financing. The State, already heavily indebted as it is the case in France, will then be confronted with even higher rates to cover its deficit and to finance the reimbursement of the loans coming at maturity. We will see then a full reversal of the debt charge trend. In the past, the refinancing of the public debt with the then low rates had as a consequence a diminution of its charge, despite the indebtedness increase. The rates rebound will generate the opposite effect because France will amortize a low rates debt and will have to replace it by bonds carrying much higher rates. The phenomenon will be even made worse with the consequences of inflation on the share of the debt which has been issued with indexation clauses.
Against the common ideas, the inflationist push is not good news for the heavily indebted states and especially for France. The fiscal receipts increase which result from it during a period which necessarily will come to an end, even if it is more or less rapidly, would not mask the point that the indebtedness charge, especially if an important share of it is indexed, will increase during a long period of time.