DBRS Confirms France at AAA, Stable Trend

DBRS Ratings Limited 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). All ratings have Stable trends. DBRS expects from the new administration an ambitious push to implement structural reforms, while keeping France committed to reaching its medium-term structural fiscal balance objective. Cyclical improvements to domestic and external demand, the end of the election cycle, and the reform agenda have created a favourable environment for growth that should continue to strengthen in the coming years.

France’s sovereign ratings reflect the high level of productivity, size, and diversification of the French economy. France’s 22% of GDP savings rate has enabled it to sustain a high rate of investment. 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 Eurozone membership provide 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.

Economic growth momentum is solid. Even though the unemployment rate (9.5%) remains high, progress in lowering labour costs has led to gradual increases in employment growth. The reduction in political risk and the recovery of external demand have pushed business and consumer confidence indicators to post crisis peaks, illustrated by strong investment growth. Real output expanded by over 0.5% (q/q) in the second quarter of 2017, for the third straight quarter. The government expects growth of 1.7% this year.

Resilient private sector balance sheets support growth. Household net wealth has increased by 25% from its pre-crisis peak, supported by the recent rise in housing prices. 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. As a consequence, outstanding credit to households and non-financial corporates 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 supported credit worthiness. Faced with a large structural deficit following the global crisis, successive administrations have taken a deliberately gradual approach to fiscal adjustment, in order to support demand growth, while committing to a medium-term objective of structural fiscal balance. The 2018 Budget forecasts a general government deficit to 2.9% of GDP this year and narrow it to 1.5% by 2020. Although estimates of the structural deficit vary, a continued economic recovery is expected to flatten France’s debt to GDP over the next few years.

Progress on fiscal consolidation has been slow due to the persistently weak recovery and low inflation. Since 2010, growth averaged 1.1% – broadly in line with IMF measurements of output potential – and inflation averaged 0.9%. Notwithstanding the moderate progress achieved to date in narrowing the deficit and despite low and declining debt servicing costs, France has less space to absorb shocks than it did prior to the crisis. Gross debt reached 96.3% of GDP in 2016, up from 64% in 2007. In keeping with the Government’s expenditure reduction strategy, real public spending is expected to grow by 0.4% on average from 2018-2022, after advancing by 0.9% from 2012-2017. A failure to curb public expenditures and reduce public sector debt over the medium-term could result in higher debt servicing costs as global interest rates rise.

France’s high rate of unemployment also poses a concern. The generous social welfare system, and relatively high labour costs combined with labour market rigidities have traditionally been associated with a higher rate of structural unemployment. This carries a substantial fiscal and social cost, and long-term unemployment tends to have lasting effects on productivity. The labour market legislation introduced by the Macron administration in September 2017 attempts to reduce rigidities principally by placing greater emphasis on company-level rather than sector-level negotiations, and by setting a compensation standard for unfair dismissals. The growth impact of labour reform, passed by executive decree, remains uncertain at this stage. It is likely only an initial step of many in this government’s ambitious labour market strategy that also seeks to transform vocational training and unemployment insurance systems.

The new administration has a unique opportunity to enact its reform agenda. In the National Assembly election, the legislative majority achieved by the president’s La Republique En Marche! party reinforced his strong mandate. The administration has set out a broad agenda to reform the labour market, support free trade, and strengthen EU integration. If implemented, this agenda reinforces the strengths that underpin the AAA ratings.

RATING DRIVERS

While Emmanuel Macron’s victory in the 2017 presidential election has reduced risk stemming from anti-EU sentiment, downside ratings pressure could still emerge. A failure to maintain strong fiscal discipline and reduce France’s high level of debt could ultimately lead to a downgrade. France could also face downward pressure on its ratings if significant adverse developments in Europe lead to renewed economic and financial stress on France’s credit quality.

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 on www.dbrs.com 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, UNDP. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Sovereing Ratings
Initial Rating Date: May 12, 2011
Last Rating Date: March 31, 2017

DBRS Ratings Limited
20 Fenchurch Street
31st Floor
London
EC3M 3BY
United Kingdom
Registered in England and Wales: No. 7139960

Information regarding DBRS ratings, including definitions, policies and methodologies, is available on www.dbrs.com.