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France delays reform to avoid government collapse

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Paris gets leeway despite mounting debt

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Bond pressure keeps France from setting a precedent

By Leigh Thomas, Jan Strupczewski and Yoruk Bahceli

PARIS, Oct 20 (Reuters) - Financial markets cheered last

week's defeat of no-confidence votes in the French government

but any reprieve in weeks of political chaos will be short-lived

unless budget talks starting on Monday find the savings needed

to cut the country's deficit.

A deal to suspend implementation of President Emmanuel

Macron's controversial hike to the state retirement age allowed

his government to live another day. But it made the task of

putting the country's finances on a stable footing more

difficult.

"We still think French debt, the political situation and the

reluctance of the French people to be ready to make sacrifices

and implement fiscal consolidation mean you need to pay more to

issue your debt," said Apolline Menut, economist at Carmignac.

S&P GLOBAL CUTS CREDIT RATING

Driving home the point, S&P Global cut France's credit

rating on Friday in a surprise update on the euro zone's

second-biggest economy, citing concerns that political

instability would keep France from getting its finances under

control.

After three downgrades from Fitch, DBRS and S&P in a little

more than a month, Moody's is next in line to update on France

at the end of the week.

Analysts say French borrowing costs at around 3.36% on its

10-year paper - roughly the same level as highly indebted Italy

- have long reflected lower ratings.

"With the current downgrade, France falls below AA- from 2

of the three rating agencies, and it should result in forced

selling from a number of institutional investors who are

sensitive to ratings," said Mohit Kumar, chief

economist/strategist Europe for Jefferies.

Prime Minister Sebastien Lecornu aims to reduce the budget

deficit to 4.7% of GDP next year from 5.4% in 2025, as a first

step toward bringing it below the EU's 3% ceiling - widely seen

as the threshold for putting debt on a sustainable path.

PLAN TO OFFSET DELAYED PENSION CHANGE

Speaking at the IMF annual meeting in Washington, European

Economic Commissioner Valdis Dombrovskis told Reuters that

suspending the pension reform carried a "sizeable cost" but

noted that the government intended to offset the impact.

Lecornu aims to tighten public finances by over 30 billion

euros through tax hikes and spending cuts - France's biggest

budget squeeze in more than a decade.

While many lawmakers in the fractured parliament are

already gearing up to dilute his savings plan, Lecornu insists

the deficit must stay below 5%.

"If lawmakers resort to obstruction with a flood of

amendments, it's going to be a rough ride - real parliamentary

guerrilla warfare," said centrist MoDem MP Erwan Balant, whose

party backs Lecornu.

LITTLE SIGN OF CONTAGION FROM FRANCE FOR NOW

So far there is little evidence of contagion to the rest of

the euro zone.

Although the risk premium on French bonds eased after the

pension reform delay, it still remains well above levels seen

before the summer of 2024 when Macron plunged France into

uncertainty with a snap election.

Public audit office head Pierre Moscovici told a Senate

hearing on the 2026 budget that France could even see its debt

levels overtake those of Italy by 2029, adding: "We are alone in

the situation we've put ourselves in."

Investors are for now reaching the same conclusion, judging

that France's political and market pain is even having a

salutary effect in encouraging others such as Italy to pursue

their deficit-cutting paths.

"Politicians will say: 'If that's the road France wants to

take, the bond market is the price they will have to pay. I

don't want to take that path, because I don't want to pay that

price in the bond market'," said Rohan Khanna, head of euro

rates strategy at Barclays.

France's EU partners are meanwhile eager to see Paris get

out of its rut to help push forward long-stalled pan-European

projects like capital markets union.

"It is true that we are watching very closely what is

happening politically in France, and I want a stable government

with which I can advance important projects," German Finance

Minister Lars Klingbeil said on a panel in Washington.