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.

Since DBRS adopted a negative trend in November 2014, France’s economy has benefited from several important tailwinds. ECB quantitative easing has kept long-term interest rates low, the euro has weakened, and average oil prices in euro terms have fallen by a third. In this context, it appears likely that the French economy will meet its growth and fiscal targets for 2015. DBRS nonetheless believes that the conditions that prompted the adoption of the Negative trend remain in place. The economic recovery has been tepid, in spite of the cyclical factors supporting growth, and could falter in the face of a less supportive external environment. Notwithstanding some progress on structural reform, these efforts may be insufficient to generate sustained and broad-based growth, resulting in continued high unemployment and hampering progress on fiscal adjustment.

Weak economic performance and fiscal management are the main factors behind the Negative trend. Authorities have reaffirmed a commitment to fiscal consolidation, following the multiyear adjustments laid out in 2015, but have not introduced any significant new measures in the 2016 budget. France could be downgraded if available evidence points to weaker growth prospects due to structural factors. France could also be downgraded if the fiscal adjustment falls short. Conversely, the trend could be returned to Stable if growth and fiscal performance continue to strengthen, alleviating concerns regarding structural impediments. Continued reforms to increase labor market flexibility could also support the 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. 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 are expected to decline to 2.0% of GDP and 3.6% of general government revenue in 2015, in spite of the continued rise in the public debt to GDP ratio.

Private sector balance sheets remain in strong condition. Housing prices have declined 7.1% from their 2011 peak, but overall household net wealth has increased by 32% 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, helping to support 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 over the past 12 months. Real GDP growth has strengthened gradually during 2015 but remains below the estimated rate of potential growth. Government growth projections remain in line with 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 recovery and low inflation, progress on fiscal consolidation has been slow. DBRS takes some comfort in the progress achieved to date. However, the government is unlikely to reach structural balance 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 prior to the global crisis, in spite of low and declining debt servicing costs. A failure to reduce public sector 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 achieve stronger productivity growth.

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 Trésor, 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.

DBRS does not typically accept editorial changes other than to correct for factual, accuracy and/or to remove confidential, material non-public, or sensitive information that might otherwise be inadvertently disclosed.

Lead Analyst: Thomas R. Torgerson
Rating Committee Chair: Roger Lister
Initial Rating Date: May 12, 2011
Most Recent Rating Update: May 1, 2015

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