DBRS Confirms France at AAA, Changes Trend to Stable from Negative

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

DBRS adopted a negative trend on France’s long-term issuer ratings in November 2014, noting concerns regarding potential structural impediments to the economic recovery. Since that time, France’s economy has benefited from stronger growth and 2015 fiscal targets have been exceeded by a small margin. Although growth has been driven in part by cyclical factors, developments over the past 18 months have helped to confirm France’s strengths, including those stemming from its strong fiscal framework and its position within Europe. Consequently, DBRS believes the evidence continues to support a AAA rating. While the outcome of France’s 2017 elections is difficult to predict, DBRS expects the overall direction of macroeconomic and fiscal policies will remain intact, enabling France’s high debt burden to be gradually reduced.

The Fiscal Management and Policy and Economic Structure and Performance sections are the main factors behind the return to a Stable trend. France continues to reduce its fiscal deficit and growth has accelerated. France has also benefited from financial strengths reflected in the Debt and Liquidity and Monetary Policy and Financial Stability sections, including the ECB’s policy stance and associated reduction in interest costs.

France could still face downward pressure on its rating if the policy response to any adverse macroeconomic developments is inadequate. At this particular juncture, DBRS believes the government has relatively little space for a deterioration in policy discipline without suffering potentially adverse effects on credit quality. A sustained commitment to the structural balance objective is needed to help ensure increased fiscal policy space to deal with future shocks. Continued progress to support growth through labor and other structural reforms could facilitate fiscal adjustment and lend support to the rating.

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 declined to 2.0% of GDP and 3.8% of general government revenue in 2015, in spite of the high public debt to GDP ratio.

Private sector balance sheets remain in strong condition. Housing prices are down 7% from their 2011 peak, but appear to have stabilized in recent months. Overall household net wealth has increased by 24% from its pre-crisis peak. 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. Outstanding credit to households and non-financial corporates has continued to rise, and bank credit growth to nonfinancial corporations has gradually accelerated over the past two years, rising 4.2% y/y as of February 2016. 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 challenges. Growth has remained below its estimated medium-term potential in spite of a gradual improvement in domestic demand. Growth was slightly higher than expected in 2015 and in Q1 2016, buoyed in part by lower energy prices, the weaker euro, and ECB monetary stimulus. While the government has made progress in lowering labor costs, streamlining regulations and easing France’s high tax burden, the cumulative impact of government measures may be insufficient to significantly increase France’s overall rate of growth and achieve a more rapid reduction in unemployment.

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. 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. The government is also engaging in negotiations to launch an additional labor market reform and reduce some of the rigidities that raise the cost of doing business in France. Nonetheless, the labor reform is still pending and may not be sufficiently ambitious to have a significant near-term impact on hiring.

Notes:

The main points discussed in the Rating Committee were: (1) medium-term growth prospects, the role of cyclical factors in recent economic performance, the impact of recent economic policy reforms on France’s potential growth rate, and pending labor market reforms; (2) progress on fiscal adjustment, and (3) the impact of ECB monetary policy actions and the overall health of the French private sector, including French banks.

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 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: October 30, 2015

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