DBRS Confirms France at AAA with a Stable Trend

DBRS, Inc. (DBRS) has today confirmed the ratings on 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 in 2009 that was less severe than in other advanced economies. Although its banking sector suffered only moderate write-downs from securitisation activities, it has been affected by stresses in wholesale funding markets. Furthermore, there has been a marked deterioration in fiscal balances with respect to pre-crisis levels resulting in a significant rise in public debt that has yet to stabilise.

The ratings reflect the 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, and high national savings. Furthermore, possible deterioration of the public sector balance sheet from a potential need for support of the French banking sector appears limited. In a context of high and rising public debt, the presence of medium term objectives for fiscal consolidation and the strong commitment to stabilising debt ratios shown by the French government support the Stable trend. DBRS believes that this commitment will continue under the recently elected government of François Hollande.

Recent political developments in Greece have called into question the Greek government’s willingness and capacity to comply with the EU-IMF adjustment programme and sustain its membership in the European Monetary Union. Uncertainty over the future of Greece, which may persist for some time given the scale of the macroeconomic adjustment required, could add to downside risks to the growth outlook in Europe, potentially making public debt stabilisation more difficult.

During the crisis of 2009 the French economy fared better than other advanced economies. Output fell from a peak in the first quarter of 2008 to a trough in the first quarter 2009 by 4.3%, while in the Euro area GDP contracted peak to trough by 5.4%. Still this has been the most severe recession in decades, and only in 2011 did output recover its 2007 peak. With high private sector saving, moderate household and manageable non-financial firms liabilities at 64.4% of GDP and 82.2% of GDP respectively, private sector deleveraging appears limited. This contributes to near and medium term growth prospects and for the quality of bank assets. Hence, it is more likely that credit will be more supportive of growth.

France’s economy is large, well diversified, and highly productive, with output per hour worked at a similar level as Germany’s and slightly below that of the United States. Productivity performance has been moderate, 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 some 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 7.6% of GDP in 2009 up from a deficit of 3.3% of GDP in 2008. Since then, the withdrawal of the stimulus package, expenditure controls, some revenue measures, as well as a modest economic recovery have reduced the fiscal deficit to 5.2% of GDP in 2011. As a result, public debt rose from 68.3% of GDP in 2008 to 86% of GDP in 2011 and more ambitious fiscal consolidation targets have been adopted to address this imbalance. These targets aim to reduce the public deficit to 4.5% of GDP in 2012, and 3% of GDP in 2013 and could stabilise public debt near 90% of GDP, including France’s share of support for the Euro area, absent further shocks.

France’s public debt has climbed well above the Maastricht ceiling of 60% of GDP to 86% of GDP in 2011. DBRS believes that returning to pre-crisis levels will require reining in structural expenditures and implementing some tax measures. This effort to improve 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, the progress achieved to date, 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 is likely to continue. This could be especially important if health care costs were to increase more than recent trends suggest. The fiscal implications of the recently elected government’s plans to revisit the 2010 pension reform, which raised the minimum retirement age by two years, are likely to be limited.

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 2011 level of 9.8%, a common characteristic of fairly rigid labor markets, despite some reforms since 2007. There has also been a steady 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 area peers. However, external financing requirements will likely remain limited as the national savings rate remains high.

With the return of modest growth of 1.5% in 2010 and 1.7% in 2011, fiscal consolidation has been on target, exceeding budget law forecasts. France’s relatively high savings rate, sustainable external financing requirements, limited support 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 could occur if fiscal imbalances are not reduced or if the fallout from events in Greece were to have systemically adverse consequences, 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 Banque de France, National Statistics Institute (INSEE), Eurostat, IMF, European Commission, OECD and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This credit rating has been issued outside the European Union (EU) and may be used for regulatory purposes by financial institutions in the EU.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

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 under Related Research.