Economic growth in France is being hindered by the country's political instability.

• On Wednesday, the French National Assembly will vote on a motion of no-confidence in the government of Prime Minister Michel Barnier, which is predicted to succeed.
• If a new 2025 budget is not introduced, economists predict that the country's deficit will increase, resulting in higher bond yields and discouraging international investors.
• The no-confidence vote in Germany adds to the challenges for the euro due to the political instability.

On Wednesday, the French government of Prime Minister Michel Barnier will face a no-confidence vote from lawmakers, with economists predicting that the resulting political stalemate will have a significant negative impact on the economy.

The government is at risk of collapse after two motions of censure were filed by both the left-wing and far-right opposition parties. The administration, which was formed just three months ago, is widely seen as likely to be ousted. If the government collapses, Barnier, who failed to find compromise within the heavily-divided National Assembly to pass a 2025 budget bill aimed at reducing the hefty French deficit, will be forced to resign to President Emmanuel Macron.

After the snap summer election, Macron struggled to appoint a new prime minister, and now he must do so again, as long-time minister Barnier was seen as a technocratic compromise.

If Barnier resigns, Macron may ask him to remain as a caretaker. However, formally renominating Barnier seems unlikely due to the clear absence of a majority, according to Carsten Nickel, deputy director of research at Teneo, in a Tuesday note.

Another possibility is that Macron's resignation could trigger presidential elections within 35 days, Nickel said.

Such a series of events would make it unlikely that the budget bill would be passed, with a last-minute deal seeming improbable.

The caretaker government is likely to present a special constitutional law that would "roll over the 2024 accounts without any spending cuts or tax hikes, while allowing the government to continue collecting taxes," he stated.

The euro is experiencing negative sentiment due to poor manufacturing data from the euro area and political instability in Germany, while French borrowing costs are increasing.

Maybank analysts warned in a note on Wednesday that France's growing fiscal deficit will become increasingly expensive to finance as their government bond yields rise amid uncertainty.

Deficit challenge

Javier Díaz-Giménez, professor of Economics at Spain's IESE Business School, stated that the situation in France looks "very bad" to international investors, according to a phone interview with CNBC.

If they don't have a budget, they will default, not because they can't pay interest on their debt, but because they won't have one. Ratings agencies are already issuing warnings, with 10-year French bonds having a higher premium than Greece's, which is unjustified based on fundamentals. Greece had briefly lost its investment grade credit rating status during the euro area debt crisis, resulting in the country's sovereign default.

Díaz-Giménez stated that pension funds are not concerned with legal issues and only seek a steady stream of revenue. As a result, they will abandon French bonds and look for other investment opportunities.

"This will lead to unsustainable debt growth in France beyond economic growth and stability."

Following the publication of the budget proposal in October, which included sweeping tax hikes and public spending cuts, economists had already reduced their growth forecasts for France.

The fall of Barnier's government would negatively impact the French economy, according to analysts at Dutch bank ING, who previously predicted French growth slowing from 1.1% in 2024 to 0.6% in 2025.

They also predicted the passing of a provisional budget mirroring the 2024 framework.

According to them, the proposed budget will not alter the course of public spending. This statement contradicts Barnier's objective of decreasing the public deficit from 6% of GDP to 5% by 2025, which would prevent France from meeting the EU's new fiscal guidelines.

The ING analysts stated that as economic growth in France slows down, it is bad news. The public deficit will remain high, debt will continue to increase, and the next government, whenever it comes to power, will face an even more challenging task to rectify public finances.

Gilles Moëc, AXA's group chief economist, stated in a Monday note that France has significant domestic savings reserves, which can replace international investors. Additionally, the euro area dataflow helps to separate European and US yields. However, in the long run, directing too much of domestic savings towards funding the government can negatively impact growth dynamics.

The government's reliance on increased consumption to support tax receipts in 2025 may be hindered by a decline in consumer confidence and a potential rise in the savings rate, according to Moëc.

German comparison

Despite both countries facing political instability, the gap between France's borrowing costs and those of Germany reached a new 12-year high this month.

The largest economy in the euro area has a more negative outlook than France, according to Díaz-Giménez of IESE Business School.

The economic outlook in France is grim, but it won't be a catastrophe if ancillary risks are avoided. The high fiscal deficit is a significant challenge that requires political harmony, but they can still find a way through. This puts pressure on politicians to perform and address the real issue of fiscal sustainability.

"In Germany, the issue is growth, as the economy requires significant adjustment to a new environment without Russian gas and where manufacturing cars in Europe appears to be an unprofitable business plan. This presents a more challenging economic problem than the one faced by France."