DBRS Confirms France at AAA, Stable Trend

DBRS, Inc. (DBRS) has confirmed the ratings on the Republic of France’s long-term foreign and local currency debt at AAA, with Stable trends. DBRS has also confirmed the short-term foreign and local currency ratings at R-1 (high) with Stable trends.

The stable trend on France’s rating reflects DBRS’ assessment that France continues to possess a high degree of resilience in responding to shocks. The French economy has faced significant headwinds, including continuing stresses in parts of the Euro zone, fragile domestic confidence, the impact of fiscal tightening, and weak corporate profitability which dampens investment. Nonetheless, DBRS believes that the government has made considerable progress toward achieving structural fiscal balance and is likely to keep its commitment to adopt an additional 1% of GDP in fiscal measures with the 2014 budget. In addition, though structural factors may be contributing to France’s weak economic performance, DBRS believes that a gradual cyclical recovery is likely to result in a stabilization of the debt within the next few years.

France’s credit ratings could come under pressure if additional evidence emerges that economic growth is being held back by significant structural rigidities in the French economy and a lack of competitiveness. In addition, there is a risk that the government may fail to follow through on additional structural reforms to support growth and fiscal measures needed to achieve its medium-term objective of structural fiscal balance. Finally, risks stemming from stresses in the Euro zone periphery, and especially further deterioration in Italy or Spain, could place additional burdens on France’s public sector balance sheet, as for other core euro area countries, due to likely spillovers to the real economy, financial system and corporate sector, and potentially have an adverse impact on demand for French government securities.

In spite of these risks, France’s sovereign ratings reflect the substantial capacity of the public sector balance sheet to weather stress. France’s economy is large, well-diversified, and highly productive, with output per hour worked higher than Germany’s and slightly below that of the United States. France’s high national savings and relatively healthy household balance sheets suggest some potential upside for growth in spite of stagnant real incomes. The banking system has made significant progress in reducing risk exposures and strengthening liquidity and capital buffers.

The government has made substantial progress toward reducing its fiscal deficit, particularly in structural terms. The government seeks to reduce its nominal fiscal deficit to below 3% of GDP by 2015 and attain structural fiscal balance by 2016. DBRS continues to believe that the commitment shown by the French government to reducing the deficit buttresses the country’s capacity to repay its debts. DBRS takes comfort in the progress achieved to date, and the present low debt financing burden resulting from the low interest rate environment. In spite of the cost of supporting weaker Euro zone countries that have lost market access, France’s Euro zone and EU membership provides numerous benefits, including a very large common market, large pools of liquid and long-term savings, and the second-most liquid reserve currency in the world.

The government has also taken several measures to support growth. The tax credit for competitiveness and employment introduced in the 2013 budget is targeted at lowering labor costs for firms employing workers earning below 2.5 times the minimum wage. While the fiscal impact has been deferred to 2014, firms are able to obtain advances from financial institutions on these tax credits to finance their operations and expand. The government has also adopted a package of measures to foster the non-cost competitiveness of small and intermediate enterprises through a variety of regulatory, financial and tax changes.

France nonetheless faces several challenges, which are intensified by the continued fragility within the Euro zone. A combination of cyclical and structural factors could continue to prevent a return to stable economic growth. The cumulative impact of government measures taken to support growth may be insufficient to counter high labor costs, high and potentially rising structural unemployment, and weak corporate profitability. Export performance has been relatively poor, in part because France relies more heavily than neighboring Germany on demand from southern Europe and the UK. Enhancing France’s competitiveness both inside and outside of Europe would likely help to fuel stronger growth.

In addition, further progress on fiscal consolidation is necessary to ensure a durable reduction in debt, and medium-term fiscal dynamics will reinforce the need for strong budget discipline. Although France has one of the highest fertility rates of any advanced economy, its public expenditures on pensions, 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.

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 principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include the Ministry of Economy and Finance, Agence France Tresor, INSEE, Banque de France, IMF, OECD, European Commission. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

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

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Thomas Torgerson
Rating Committee Chair: Alan G. Reid
Initial Rating Date: May 12, 2011
Most Recent Rating Update: June 7, 2012

For additional information on this rating, please refer to the linking document under Related Research.