France is becoming the ‘poster child’ of sovereign debt problems as government borrowing costs hit near 2008 highs

France's deteriorating public finances and political deadlock are becoming a growing concern for bond investors, with borrowing costs near financial-crisis-era highs as another difficult budget battle looms.

The European Union's second-largest economy has endured recurring political instability and mounting fiscal strain in recent years. It has repeatedly broken European Commission rules on budget deficits and debt limits, and successive prime ministers have been ousted after failed attempts at reform, spending cuts and tax rises to bring the situation under control.

France is subject to the EU's excessive deficit procedure, with the Council recommending that it end its excessive deficit by 2029 — but it has a long way to go.

EU treaties set reference values of 3% of GDP for government deficits and 60% for government debt. Last year, France's deficit reached 5.1% of GDP, while the debt-to-GDP ratio surpassed 115%.

The IMF projected in July that France's gross government debt would reach about 118.5% of GDP in 2026 and exceed 120% in 2027, remaining above that level through 2030.

At the same time, the economy is struggling to grow, contracting 0.2% quarter-on-quarter in the first three months of this year and stagnating in the second quarter.

The upheaval has caused acute stress in the country's bond markets, with French government bond yields rising dramatically over the past year — exacerbated by the U.S.-Iran war's impact on borrowing costs worldwide — giving France some of the highest government borrowing costs in the G7.

French 10-year government bond yields hit their highest level since 2008, above 4.13%, last week and remained near 4.1% on Friday. Bond yields and prices move in opposite directions.

France 10-year government bond yield

The French National Assembly is ideologically fractured, leading to no-confidence votes, government collapse and deadlocks over the national budget.  

France is expected to submit its 2027 budget plans to parliament by early October. Last year's budget led to a deadlock that saw Prime Minister Sebastien Lecornu force the bill through parliament after months of delays.

Lecornu became the fifth person to hold the role in just two years when he was appointed in 2025. His resignation just 27 days into the job, saying political discord had made it too difficult to build a workable government program. Lecornu was reappointed days after quitting.

Another source of uncertainty that's weighed on French bonds is the 2027 presidential election, where far-right candidate Marine Le Pen is currently the frontrunner to succeed Emmanuel Macron.

'Poster child' for debt problems

John Stopford, head of multi-asset income at Ninety One, told CNBC that swelling deficits and slowing growth have become a global problem in the wake of the Covid-19 pandemic, wars and successive energy crises, but France "stands out."

"It's not just a French problem, but you could argue that in many ways France is one of the poster child [countries]," he said on a call. "So I don't think it's unique to France [but] France's public finances have been going in the wrong direction."

There is a broader challenge, he said, for developed governments to find a way to balance their books and bring debt onto a more sustainable path. Failing to do so is likely to lead to a "bond market revolt" at some point, Stopford added.

"I can see why people are concerned," he said of France. "It's not obvious how this ends in a good way."

The big uncertainty hanging over the OATs market is next year's presidential election, Stopford said.

During a candidate debate on Thursday, Le Pen said that the government "must drastically cut its spending," adding that she was "extremely concerned" about the trajectory of Paris's debt levels.

But Stopford told CNBC the market had been skeptical about whether Le Pen had much appetite for putting the public finances on a more sustainable footing.

"Clearly we may get a change of regime or policy priorities post May next year, but people doubt that there's much appetite for material fiscal consolidation," he said. "So yes, I think we might be building up to a crisis. I'm just not sure it's today."

Théophile Legrand, a rates strategist at Natixis CIB, told CNBC that his team already views OATs as "pre-stressed."

"What could delay a recovery is not only domestic politics, but also the broader macro backdrop," he said. "The market is not expecting France to return to a 3% deficit as early as 2027, but it does look for signs that the 2027 budget is consistent with a credible medium-term path for stabilizing public debt. That path is becoming harder to deliver. The war-related backdrop and higher long-end rates already complicate the fiscal equation, while this summer's heatwaves and wildfires add another layer of uncertainty."

The final months of this year and the first quarter of 2027 were the most likely window for another bout of volatility in OATs, Legrand added, as the budget debate and presidential dynamics become more closely intertwined. 

"That said, we do not expect a repeat of the 2024/2025 shock pattern. OAT valuations already look materially stressed: our fair value model suggests OATs are around 15 basis points cheap even before adding any political premium, and our year-end forecast is around 75 basis points on the 10-year OAT-Bund spread if the budget is passed, versus around 80 basis points if it is not and France moves to a special budget law," he said.

April LaRusse, head of investment specialists at Insight Investment, said that despite increasingly bleak headlines related to the French economy, there is "surprisingly little sign that France is preparing for the kind of fiscal adjustment that its debt dynamics would seem to require."

"Growth expectations are being revised lower, debt is set to keep rising and bond yields are now at levels not seen since the financial crisis," she said. "Yet meaningful spending restraint remains politically difficult. With pension reform effectively on hold until after the 2027 election and parliament deeply fragmented, the government appears focused on maintaining political stability rather than tackling the underlying fiscal problem."

The question for investors now, she said, is whether policymakers can muster the political will to put public finances on a more sustainable path before market pressures intensify.

"French government bonds already trade more cheaply than their Italian equivalents, which would have been unthinkable not that long ago — but they could get even cheaper in a negative scenario," she said.