DBRS Assigns AAA Rating to France

DBRS Inc. (DBRS) has today assigned ratings to the Republic of France’s long-term foreign and local currency debt at AAA. The trend on both ratings is Stable. The French economy has shown resilience to the global downturn, with a recession that has been less severe than in other advanced economies. Its banking sector appears stable as it has not suffered large write-downs from securitisation activities or from other impaired assets. Nevertheless, there has been a marked deterioration in fiscal balances resulting in a significant rise in public debt that has yet to stabilise.

The ratings reflect the strong capacity of the public sector balance sheet to weather stress, which is underpinned by moderate growth prospects for a mature economy, a high level of productivity, high national savings and a stable financial sector. Furthermore, in a context of high and rising public debt, the strong commitment to stabilising debt ratios shown by the French government supports the Stable trend. The withdrawal of stimulus measures, the recently approved pension reform and freezes and cuts in the public administration budget are some of the main measures adopted to begin restoring fiscal balance and improve long term fiscal sustainability.

During the crisis, the French economy fared better than other advanced economies. Output fell from its peak in the first quarter of 2008 to its trough in the first quarter 2009 by 4.0%, while in the Euro zone GDP contracted peak to trough by 5.6%. Still this has been the most severe recession in decades, and output will likely recover only later this year. With high private sector saving, moderate household and non-financial firms liabilities at 69% of GDP and 65.6% of GDP respectively, private sector deleveraging appears limited. This contributes to near-term growth prospects and for the stability of the banking sector. Hence, it is more likely that credit, although still lagging growth, may be supportive of the recovery.

France’s economy is large, well-diversified, and highly productive, with output per hour worked at a similar level as Germany’s and only slightly below that of the United States. Productivity performance has been good, growing at an average of 0.61% per year for the period 1999 through 2007, and accounting for 29% of real value added growth. Throughout the crisis growth was driven more by internal demand, and especially consumer spending, than external demand, making the economy more resilient to adverse global economic conditions.

Despite these strengths, controlling the fiscal deterioration and the rapid rise in debt is a significant challenge. The sharp increase in expenditures in 2009, as France’s automatic stabilisers and the stimulus package went into effect, delivered a public deficit of 7.5% of GDP in 2009 and 7.0% of GDP in 2010, up from a public deficit of 3.3% of GDP in 2008. As a result, public debt rose from 67.5% of GDP in 2008 to 81.7% of GDP in 2010 and more ambitious fiscal consolidation targets have been adopted to address this imbalance. These targets aim to reduce the deficit to 5.7% of GDP in 2011, 4.6% of GDP in 2012, and 3% of GDP in 2013 and would likely stabilise public debt below 87% of GDP starting in 2012.

France’s public debt has climbed well above the Maastricht ceiling of 60% of GDP to 81.7% in 2010. DBRS believes that returning to pre-crisis levels will require reining in structural expenditures and implementing some tax measures. This effort to bring about significant improvements in the structural fiscal balance will need to be sustained over the medium term. In spite of this challenge, DBRS takes comfort in the strong commitment shown by the government to its fiscal targets and the present low debt financing burden resulting from the low interest rate environment.

Although France has one of the highest fertility rates of any advanced economy, its public expenditures on pension, health and long-term care are among the highest in the world, accounting for about 23% of GDP. With the old age dependency ratio projected to increase from 25.8% in 2010 to 32.8% in 2020, pressure on fiscal accounts may continue. This could be especially important if health care costs were to increase more than recent trends may suggest. However, the 2010 pension reform, which raised the minimum retirement age by two years, has improved the medium- and long-term finances of the public pension system.

The severity of the 2009 downturn may have adversely affected France’s already high structural unemployment rate. Over the past two decades the unemployment rate reached its lowest level, 7.5%, in early 2008, and it will take some time to fall back from its end of 2010 level of 9.6%, a common characteristic of fairly rigid labor markets, despite some reforms undertaken since 2007. There has also been a steady but modest deterioration in the current account balance driven by a worsening of the trade balance, as France’s share of world exports has fallen more than some of its Euro zone peers. However, external financing requirements will likely remain limited as the national savings rate remains high.

The capacity of the public sector balance sheet to weather stress has been weakened, however with the return of modest growth of 1.5% in 2010 and an estimated 1.7% in 2011, fiscal consolidation is becoming easier to implement. France’s relatively high savings rate, no material external financing requirements, the aggregate stability of the banking sector, and manageable levels of household and non-financial firm indebtedness provide important sources of strength. Nevertheless, if public debt levels fail to stabilise, which DBRS views as unlikely given the strong government commitment to its fiscal targets, the ratings could come under downward pressure.

Notes:
All figures are in Euros unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the French Ministry of Economy, Finance and Industry, the Ministry of Budget, Bank of France, National Statistical Institute (INSEE), Eurostat, OECD, BIS and IMF. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is the first DBRS rating on the Republic of France.

Lead Analyst: Pedro Auger
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 12 May 2011
Most Recent Rating Update: 12 May 2011

For additional information on this rating, please refer to the linking document below.