DBRS Confirms France at AAA, Trend Remains Negative

DBRS, Inc. (DBRS) has confirmed the ratings on the Republic of France’s long-term foreign and local currency debt at AAA. The trend remains Negative. 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 weak economy, slow progress on structural reform, and lagging fiscal consolidation could have a lasting impact on France’s 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 structural fiscal balance and remains committed to gradual consolidation. Nonetheless, while the economy appears poised for a cyclical rebound, the fiscal effort remains predicated on sustained growth and inflation assumptions that may not materialize.

Weak economic performance and fiscal management are the main factors behind the Negative trend. Authorities have reaffirmed their commitment to fiscal consolidation and have adopted more conservative macroeconomic assumptions for the 2015-17 fiscal trajectory. Nonetheless, additional fiscal measures proposed in the 2015 Stability Program are modest in size. France could be downgraded over the next 6 to 12 months if structural rigidities and poor competitiveness continue to result in weak economic growth and in further delays in fiscal consolidation and the expected stabilization of the debt to GDP ratio. Finally, notwithstanding the European Central Bank’s efforts to stimulate a recovery, a renewed deterioration in other European countries could have an impact on France’s ratings.

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. Interest payments on general government debt remain low at 2.1% of GDP and 4.0% of general government revenue, in spite of the steady rise in the public debt to GDP ratio.

Private sector balance sheets remain in strong condition. Housing prices have declined 6.3% from their 2011 peak, but overall household net wealth has increased by 29% since 2009. French banks were relatively resilient during the global financial crisis and have rebuilt capital positions. Similarly, non-financial corporations were not significantly overextended prior to the crisis, and have demonstrated their resilience amid weak economic conditions. The growth of credit to households and nonfinancial corporates has slowed, but outstanding credit has continued to rise. 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, limiting the adverse impact on demand growth across Europe, while committing to a medium-term objective of structural fiscal balance.

France nonetheless faces significant challenges. Growth remains weak in spite of some signs of cyclical improvements late in 2014. Growth is expected to strengthen gradually during 2015 but remain below the estimated rate of potential growth. Government growth projections remain conservative relative to consensus at 1.0% in 2015 and 1.5% in 2016, in spite of the ECB’s efforts and favorable external developments. 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 increase France’s competitiveness within the Eurozone and generate a sustained economic recovery.

With a weak economy, low inflation, and mounting political opposition, progress toward fiscal consolidation has been slower than expected. DBRS takes some comfort in the progress achieved to date. However, the government is unlikely to achieve the 3% nominal deficit target until 2017. Structural balance will not be reached until 2018 or 2019, according to government projections, and DBRS believes there are downside risks to this estimate. France has less space to absorb shocks than it did in the past, in spite of low and declining 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 combined with rigidities in labor and product markets 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. In this context, the government is working to improve worker training and adult education, and undertaking reforms to strengthen competition within various sectors and professions. Nonetheless, additional efforts may be required to return France to a stronger rate of productivity growth.

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 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: November 7, 2014

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