DBRS Confirms France at AAA, Stable Trend

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

Economic and fiscal performance remains in line with expectations, and should continue to strengthen over the course of the coming year. DBRS expects broad policy continuity, in spite of some uncertainty headed into 2017 elections. The new government’s priorities will nonetheless be important to the rating, given the need for a sustained commitment to France’s medium-term structural balance objective.

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 and is one of the world’s foremost tourist destinations. 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 recently begun to rise again, particularly in the Ile-de-France region. Household net wealth has increased by 25% 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 remains strong, rising 4% y/y as of January 2017. 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% of GDP by 2017. Although estimates of the structural deficit vary by a considerable margin and may exceed the government’s estimate of 1%, a continued economic recovery would likely put France’s debt on a downward trajectory.

Growth came in below expectations in 2016, and the resulting fiscal deficit came in 0.1% above the government’s target. The government has made progress in lowering labor costs, streamlining regulations and easing France’s high tax burden. The cumulative impact of government measures appears to have had a measurable impact on corporate investment, competitiveness and employment growth, but unemployment is falling only gradually. 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 next government’s commitment to fiscal consolidation will likely be tested, via political and social opposition to spending cuts. 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 curb high public expenditure and 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. Additional labor market reforms pushed through in 2016 seek to reduce some of the rigidities that raise the cost of doing business in France. The impact of the labor reform remains uncertain, but job creation has accelerated in 2016 to reach its highest level since 2007.

DBRS expects broad policy continuity following the election, with polls suggesting that the National Front will likely enter the second round but fail to win the Presidency. Nonetheless, a victory by a far right or far left candidate would likely raise questions regarding France’s role and relationships in the euro area and EU. In particular, proposals to engineer an exit from the euro to engage in a competitive devalution would likely prove highly disruptive to financial markets in France and elsewhere in the euro area. DBRS remains of the view that France’s credit fundamentals have benefited from the development of a vibrant, rules-based common market in Europe. Efforts to roll back France’s integration with Europe would likely do lasting damage to the economy and overall wealth of the country.

RATING DRIVERS

A failure to maintain strong fiscal discipline and gradually reduce France’s high level of debt as the economy recovers could ultimately lead to a downgrade. If election outcomes later this year point to a significant reorientation in economic policy, and particularly to a potential exit from the EU and euro area, this would likely have adverse implications for the rating. Finally, France could face downward pressure on its ratings in the event of significant adverse developments in Europe, particularly economic and financial stresses stemming from a potential weakening of euro area cohesion.

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, Insee, Banque de France, Agence France Tresor, High Council on Public Finances, IMF, OECD, European Comission, Eurostat, UN. 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, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer – Global Financial
Institutions Group and Sovereign Ratings
Initial Rating Date: May 12, 2011
Last Rating Date: October 28, 2016

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