DBRS Confirms France at AAA, Trend Changed to Negative

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

The Negative trend reflects DBRS’ concern that a stagnant economy, limited progress on structural reform, and lagging fiscal consolidation could have a lasting impact on France’s strong credit fundamentals. DBRS believes that France possesses a strong capacity to repay its debt obligations and a high degree of resilience to shocks. The government has made considerable progress toward its objective of achieving structural fiscal balance and remains committed to gradual fiscal consolidation. However, the fiscal effort – a portion of which relies on nominal expenditure freezes – has been predicated on higher real growth and inflation assumptions. Efforts at structural reform have thus far been insufficient to generate growth on par with France’s estimated rate of potential growth, and the fiscal effort is consequently falling short.

Weaker economic performance and fiscal management are the main factors behind the Negative trend. In addition, the political commitment to fiscal consolidation appears to be softening. France could be downgraded over the next 12 to 18 months if the economy remains stagnant, held back by structural rigidities in the French economy and declining competitiveness. France could also be downgraded if there is insufficient progress on fiscal consolidation. Finally, while France is benefiting from the European Central Bank’s efforts to stimulate a recovery, a renewed deterioration in other European countries could have significant spillovers to France’s real economy, financial system and corporate sector.

France’s sovereign ratings reflect the high level of productivity, size, and diversification of the French economy. A high savings rate has enabled France to sustain a high rate of investment, and the country benefits from high quality infrastructure. In addition, a generous social welfare system helps to reduce fluctuations in output. The combination of a large pool of domestic savings and France’s EU and Eurozone membership provides the public sector with a high degree of financial flexibility. France enjoys a large common market, a highly credible central bank and the second-most liquid reserve currency in the world. Interest payments on general government debt remain low at 2.1% of GDP and 4% of general government revenue, in spite of the steady rise in the public debt to GDP ratio.

French banks were relatively resilient during the global financial crisis and have rebuilt capital positions. Recent ECB/EBA stress tests support DBRS’ assessment that the banks are in a strong position to weather shocks. Similarly, non-financial corporations and households were not significantly overextended prior to the crisis, and have demonstrated their resilience amid weak economic conditions. Credit growth has slowed, but outstanding credit has continued to rise. In spite of growth challenges, resilient private sector balance sheets made France’s recession relatively shallow and have helped minimize risks to the public sector balance sheet.

The government’s commitment to gradual fiscal consolidation has also been an important strength. Faced with a large structural deficit, the Hollande administration has taken a deliberately gradual approach to fiscal adjustment, helping to cushion the impact on demand growth across Europe, while committing to a medium-term objective of structural fiscal balance.

France nonetheless faces significant challenges as it draws near to its third year of close to zero growth. Government growth projections have been revised downward from 1% to 0.4% in 2014 and 1.7% to 1% in 2015. The High Council on Public Finances has cautioned that the forecast for 2015 may be optimistic, and has expressed concern over the medium-term growth projections in the stability program. While the government has made progress in lowering labor costs, streamlining regulations and alleviating France’s high tax burden, the cumulative impact of government measures may be insufficient to restart economic growth.

With a stagnant economy, low inflation, and mounting political opposition, progress toward fiscal consolidation is also slowing. The government is unlikely to achieve the 3% nominal deficit target until 2017 and structural balance until 2020. DBRS takes some comfort in the progress achieved to date, but sees rising risks that the government’s response to the weak economic conditions will be insufficient to stabilize the debt ratio within a reasonable timeframe. French authorities expect gross public debt to peak at 98% of GDP in 2016; the IMF expects the peak to come one year later at 99% of GDP. France has less space to absorb shocks than it did in the past, in spite of the currently low debt servicing costs. A failure to reduce debt over the medium-term, particularly as the economy returns to its potential rate of economic growth, could result in materially higher debt servicing costs as global interest rates rise.

France’s high rate of unemployment also poses a concern. The generous social welfare system has traditionally been associated with a higher rate of structural unemployment, and relatively high labor costs may continue to weigh on the pace of job creation. This carries a substantial fiscal and social cost, and long-term unemployment could have lasting effects on productivity growth. In this context, the government is working to improve worker training and adult education, but additional efforts may be necessary.

Finally, France’s demographics reinforce the need for strong budget discipline. Although France has one of the highest fertility rates of any advanced economy, public expenditures on pensions, health, and long term care are among the highest in the world. 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.

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, and other analysis and research by private sector entities. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer and did not include participation by the issuer or any related third party.

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 R. Torgerson
Rating Committee Chair: Alan Reid
Initial Rating Date: May 12, 2011
Most Recent Rating Update: May 30, 2014

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