DBRS Confirms France at AAA, Stable trend

DBRS, Inc. has confirmed the Republic of France’s long-term foreign and local currency issuer ratings at AAA, and short-term foreign and local currency issuer ratings at R-1 (high). The trend on all ratings is Stable.

France’s gradual economic recovery and fiscal consolidation strategy appear largely intact, in spite of potential headwinds from Brexit and some risk of fiscal slippage heading into 2017. Although DBRS believes that the overall direction of economic policies is unlikely to change following the 2017 elections, the new government’s overall fiscal strategy and commitment to the structural balance objective will be important 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.

Private sector balance sheets remain in strong condition. Housing prices declined 7% from their 2011 peak, but have stabilized in most regions and have begun to rise again in Ile-de-France. Overall household net wealth has increased by 26% 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 4.9% y/y as of September 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. The government expects to reduce the general government deficit to below 3.0% by 2017, and estimates that this will be just 1.1% shy of structural 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. Thus far, the UK’s vote to leave the EU has had a limited impact on the French economy, but weak growth in the UK or an effective increase in barriers to trade and investment between the two neighbors would likely have adverse consequences for France.

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 2019 or 2020. 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 has pushed through additional labor market reforms this year, seeking to reduce some of the rigidities that raise the cost of doing business in France. The impact of the labor reform remains uncertain, but recent data points to a pickup in hiring.

RATING DRIVERS
France could face downward pressure on its ratings if the policy response to any adverse macroeconomic developments is inadequate. In addition, a failure to maintain strong fiscal discipline and gradually reduce France’s high level of debt could ultimately lead to a downgrade. A sustained commitment to the structural balance objective is needed to help ensure increased fiscal policy space to deal with future shocks. Recently passed labor market reforms should also help foster employment growth in the medium term, though the ultimate effects could depend on the persistence of political opposition, the extent of changes to the labor code, and the policies of the next government.

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. These can be found at http://www.dbrs.com/about/methodologies.

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 rating was not initiated at the request of the rated entity.

The rated entity or its related entities did not participate in the rating process. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities.

This is an unsolicited credit rating.

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: Roger Lister
Initial Rating Date: May 12, 2011
Most Recent Rating Update: April 29, 2016

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