Morningstar DBRS Confirms Republic of France at AA (high), Stable Trend

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Republic of France's (France) Long-Term Foreign and Local Currency - Issuer Ratings at AA (high). At the same time, Morningstar DBRS confirmed France's Short-Term Foreign and Local Currency - Issuer Ratings at R-1 (high). The trend on all ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS
The Stable trend reflects Morningstar DBRS' view that France's high financial flexibility, strong debt management and economic strengths will support the country's credit standing in the context of a challenging fiscal trajectory. While France will likely miss its fiscal deficit projections included in its April 2024 Stability Programme, including a deficit below 3% of GDP in 2027, Morningstar DBRS foresees a gradual reduction of the fiscal deficit over time. Moreover, the new European economic governance framework will likely represent an important mitigant factor for a significant delay in the improvement in public finances. Nonetheless, Morningstar DBRS takes the view that higher political fragmentation in the National Assembly since the July 2024 snap legislative elections could significantly postpone an effective fiscal consolidation and will therefore monitor how this new political setting will influence upcoming fiscal and economic decisions, including the 2025 budget. Morningstar DBRS will also pay attention the fiscal path to be unveiled in France's upcoming medium-term fiscal-structural plan, for which France has asked the European Commission (EC) for an extension to the September 20 deadline, and the implications for the country's fiscal trajectory of the opening of an excessive deficit procedure by the EC during the summer 2024.

France's AA (high) ratings remain underpinned by the country's wealthy and diversified economy, sound public institutions, and strong public funding profile. France is a core member of the euro area and financial stability risks are contained. The economy is resilient during crises due in part to strong social protections. Nevertheless, the country has the highest level of public expenditure-to-GDP among advanced economies which has historically proved difficult to reduce, making fiscal rebalancing more challenging.

CREDIT RATING DRIVERS
Morningstar DBRS could upgrade France's credit ratings if the implementation of fiscal consolidation without hampering economic growth leads the public debt ratio to a sustained downward path.

Morningstar DBRS could downgrade France's credit ratings if there is a failure to address fiscal imbalances over the medium-term, or if the political environment materially weakens the effectiveness of the government's economic policy.

CREDIT RATING RATIONALE

The Commitment To Tackle France's High Fiscal Deficit As Outlined In The April 2024 Stability Programme Will Need Decisive Government Action

The recurring economic shocks since 2020 and the government's exceptional support measures to protect businesses and households have led to a significant deterioration of the fiscal balance. The fiscal deficit reached a peak of 8.9% of GDP in 2020 before declining to 6.6% in 2021 and to 4.7% in 2022. In 2023, the fiscal deficit of 5.5% of GDP was higher than the government's latest estimate of 4.9% of GDP, mainly due to lower than anticipated tax revenues, while inflation-related support measures continued to weigh on the fiscal balance. Accounting adjustments related to the switch of the national accounts to the 2020 base also negatively impacted the 2023 deficit for around 0.15% of GDP. Last year's result was well above the 2017-2019 average fiscal deficit of 2.7% of GDP. In response to the 2023 deficit slippage and its downward revision of real GDP growth for 2024, the government swiftly reduced by EUR 10 billion the level of spending planned for this year. This spending adjustment followed the quasi-complete unwinding of inflation-related exceptional budgetary measures in the 2024 budget law. Morningstar DBRS understands that additional fiscal measures are needed to meet the 5.1% deficit which is the target for this year included in the April 2024 Stability Program. In order to meet the target of a deficit below 3% of GDP in 2027, significant fiscal adjustment will be needed in the near term, starting with the 2025 budget. However, higher political fragmentation in the National Assembly since the July 2024 snap legislative elections could hinder decisive government action. Morningstar DBRS will also pay attention to France's upcoming medium-term fiscal-structural plan, the reforms associated and the implications for the country's fiscal trajectory of the opening of an excessive deficit procedure by the European Commission during the summer 2024.

France's public sector accounts remain stressed by high structural public spending. The total general government expenditure-to-GDP ratio stood at 57.3% in 2023, the highest in the EU which has an average of 49.3%. Social protection and public health expenditure accounted for 32.9% of GDP in 2022 versus 27.2% on average in the EU. Potentially unsuccessful upcoming fiscal adjustments, a weaker than expected economic performance, or both, could reduce the pace of fiscal consolidation and challenge the government's deficit target of below 3% for 2027.

France Benefits From Very High Governance Indicators But Higher Political Fragmentation and Polarization Could Prove Challenging For Economic and Fiscal Policy Setting

France's credit ratings are supported by high institutional strength and very strong governance indicators including the rule of law. President Macron was re-elected in April 2022 after defeating Marine Le Pen of the "Rassemblement National" by a narrower margin than in 2017. While the ruling coalition lost its absolute majority in the June 2022 legislative elections, the government recommitted to its reform agenda, including the pension reform passed in March 2023. However, the July 2024 snap legislative elections reflected the growing political fragmentation and polarization of the French electorate. Morningstar DBRS considers that the fragmented composition of the National Assembly could constrain effective economic and fiscal policy setting by the new government led by Prime Minister Barnier appointed on September 5, 2024, given the higher risk of successful vote of no confidence compared to the previous legislature. Morningstar DBRS will monitor how this new political setting will influence upcoming fiscal and economic decisions, including the 2025 budget. The government should submit the 2025 draft budget to the National Assembly in October and the adoption of the budget is expected by year-end. Next scheduled national election in France is the Presidential election in 2027. As per France's Constitution, no further dissolution shall take place within a year following snap legislative elections, which in practice means before mid-2025.

High Government Debt Mitigated by Strong Public Debt Profile

The various shocks in recent years have resulted in a large increase in France's public debt burden. The debt-to-GDP ratio increased from 98.1% in 2019 to 114.8% in 2020, albeit then declining to 109.9% in 2023. The April 2024 Stability Program foresees this ratio increasing to around 113% in 2025 and then gradually declining to 112% by 2027. The country's high debt ratio remains a vulnerability for France as it exposes the country to increases in interest rates. Interest costs are expected to increase from 1.3% of GDP in 2020 to 2.6% by 2026, according to the April 2024 Stability Program. However, France continues to benefit from its very strong debt management. The central government took advantage of favourable financing conditions before the European Central Bank's monetary tightening to extend the average maturity of its negotiable debt, which stood at 8.5 years as of end-July 2024, ensuring a gradual passthrough from higher rates to higher funding costs. These features, along with France's large and diversified investor base, support Morningstar DBRS' positive qualitative adjustment for the "Debt Management and Liquidity" building block assessment.

Despite Various Macroeconomic and Geopolitical Headwinds, the French Economy Remains Resilient

The French economy and labour market faced various challenges last year including a challenging global trade environment, monetary tightening, high inflation and a relatively weak economic environment in Europe, especially in Germany, which is a key trade partner for France. Nevertheless, real GDP grew by 1.1% (seasonally and working-day adjusted) versus 0.4% on average in the Euro area. The national unemployment rate remains at historically low levels standing at 7.3% in Q2 2024. While many of those same headwinds are persistent this year, the French government expects real GDP growth of 1.0%. In its September Economic Update, the French national statistics and economic studies agency estimates that GDP growth would reach 1.1% this year. Foreign trade and public investments should support economic growth, which should also get a temporary boost from the Olympic and Paralympic Games. Private consumption has increased moderately in the first half of 2024 but should accelerate by the end of the year thanks to the continued purchasing power gains in recent years, the lower inflation environment and the likely decline of households' high savings ratio. Inflation has declined sharply in the last eighteen months and is estimated at 1.8% YoY in August 2024. This should support consumer confidence and contribute to a reduction of households' gross saving ratio, which was around 17% in 2023 and in Q1 2024 compared with 14% on average between 2014 and 2019.

Financial Stability Risks Contained Despite Tight Monetary Policy

Morningstar DBRS considers the French banking system to be sound overall, albeit one of the least profitable banking systems in Europe. Rising interest rates have further pressured net interest income of French banks, in particular of those with large exposures to the French retail market. However, in H1 2024, the strength in corporate and investment banking, asset management and insurance drove an increase in aggregate revenues. This was partly offset by higher expenses and higher credit costs. With the combined effects of elevated inflation, high interest rates for borrowers and pull back of government support, pressure on bank balance sheets could arise. The last twelve months' cumulative corporate defaults currently stand above the 2010-2019 average, primarily due to a catch-up effect. Nevertheless, French banks confronted those headwinds well capitalised, and asset quality metrics have remained resilient so far. The aggregate Common Equity Tier 1 capital (CET1) ratio stood at 15.9% in Q1 2024 versus a pre-pandemic level of 15.3% in Q4 2019, and the ratio of nonperforming loans to total loans was 2% in Q1 2024 versus 2.5% in Q4 2019. Morningstar DBRS considers that potential vulnerabilities could stem from particular sectors, such as construction and commercial real estate (CRE).

Non-financial corporations (NFCs) and households also appear resilient in the current financial environment, despite showing higher debt-to-GDP levels than the euro area average. NFCs benefit from a fixed-rate oriented debt structure, robust margins and high cash levels. Although the French residential real estate market faces an ongoing price and volume correction as demand contracted due to higher interest rates on new loans, related financial stability risks are contained thanks to the low unemployment rate, high household savings rate and the French mortgage funding model, typically made of fixed-rated and long maturity loans.

External Sector Risks Are Relatively Limited

France does not have material external imbalances. France's current account deficit, which averaged 0.3% of GDP from 2015 to 2019, widened to 2.1% in 2020 as the pandemic affected tourism and service sector inflows and dampened the export performance of the aeronautics and automobile industries. After a surplus of 0.3% in 2021, the current account deficit reached a deficit of 1.2% of GDP in 2022 due to the energy shock and decreased to 1% in 2023 on the back of decreasing energy prices, but the trade deficit in 2023 remained much higher than in the pre-pandemic years. The IMF expects the current account deficit to gradually narrow towards balance by 2029. The net international investment position (NIIP) stood at -28.1% of GDP in 2023. France's open economy with extensive trade, investment, and financial linkages throughout Europe and globally support the positive qualitative adjustment for the "Balance of Payments" (BOP) building block assessment. External liabilities are primarily denominated in local currency. Moreover, despite a negative NIIP, the BOP investment income is largely positive thanks to the foreign direct investment (FDI) portfolio return.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental, Social or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://dbrs.morningstar.com/research/439775/.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include France's Stability Programme for 2024-27, National Institute of Statistics and Economic Studies (INSEE), Banque de France (Macroeconomic Projections, June 2024; Financial Stability Report, June 2024), Agence France Tresor, Eurostat, European Commission (European Economic Forecast Spring 2024), International Monetary Fund (World Economic Outlook, April 2024), World Bank, Bank for International Settlements (BIS), OECD, the Social Progress Imperative (2024 Social Progress Index), Haver Analytics. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: YES
With Access to Management: YES

Morningstar DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/439773/.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Mehdi Fadli, Senior Vice President, Sector Lead, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: May 12, 2011
Last Rating Date: March 22, 2024

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