DBRS Confirms Republic of 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 its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trends on all ratings are Stable.

The stable trend is underpinned by the government’s clear commitment to improving its macroeconomic outcomes. DBRS expects the Macron administration to continue its push to implement ambitious structural reforms, while keeping France committed to reaching its medium-term structural fiscal balance objective and to lowering the public-sector debt burden. Several factors, though primarily the cyclical economic recovery across Europe and the confidence boost to France from the government’s economic policy agenda, have created a favourable environment for growth overperformance that should continue this year.

France’s sovereign ratings reflect the high level of productivity, size and diversification of the French economy. The country benefits from high quality infrastructure, is one of the world’s foremost tourist destinations, and has a leading position in the production of high technology products and luxury goods. In addition, the country’s large pool of domestic savings and the Treasury’s strong funding profile provide the public sector with a high degree of funding flexibility. France also benefits from the large common market, a highly credible central bank and one of the world’s most liquid reserve currencies.

The country’s strengths are balanced by several credit weaknesses, including high public-sector debt and still high measures of unemployment. Contrary to almost all eurozone countries whose debt ratios are on a declining trajectory, France’s debt ratio is expected to peak over the next few years just under 97% of GDP, according to the European Commission (EC). The high debt burden limits the country’s ability to respond to future shocks. While progress in the labour market is evident by the decline in France’s harmonized seasonally-adjusted unemployment rate to 9.0% in January 2018, from 9.6% in August 2017, the rate remains above the European Union’s aggregate 7.3% rate. Persistently high unemployment carries fiscal and social costs and can have lasting effects on productivity.

STRONG POLITICAL AND ECONOMIC OPTIMISM

The new administration was quick to launch its ambitious agenda to reform the labour market and strengthen budgetary performance shortly after the presidential and legislative elections in mid-2017. Last September, the administration built on the previous government’s changes to the labour market by passing additional reform measures with little resistance. The broad reform agenda aims to reduce market rigidities and the cost of labour. On the budget, the objective is to reduce current public spending, while increasing public investment and lightening the tax burden on households and companies.

Reform momentum will continue this year, as the government plans to reform the unemployment benefits systems, the professional training system, and the railway sector. If successfully implemented, the reforms could increase employment and productivity growth – two longstanding factors that weigh on measures of growth potential. Reform measures have increased the EC’s calculation of growth potential to 1.3% by 2019, up from 1.0% in 2016, but still below pre-crisis rates of 1.5-2.0%.

The reform momentum in France has helped boost economic confidence. Annual GDP growth increased sharply to 2.0% in 2017, up from 1.1% in 2016. Economic activity has been primarily driven by strong growth in private investment. Corporate investment has held up following the end of the over-amortisation scheme, a fiscal program to incentivize firms to invest. Even as stronger inflationary pressure starts to emerge, up to 1.2% yoy in February 2018, weighs on household purchasing power, cuts to the labour tax wedge and healthy employment growth support household consumption. Consensus forecasts are for economic growth to remain around 2.0% this year and 1.8% in 2019.

France’s favourable domestic growth performance has coincided with strong economic recoveries across eurozone countries. France has a highly open economy with extensive trade, investment and financial linkages throughout Europe and around the world. Despite some competitiveness challenges associated with labour market rigidities, the total volume of French exports, at €658 billion in 2017, is at an all-time high. With modest deficits in the current account balance (-1.2% of GDP in 2017) and the international investment position (-24.2% of GDP as of September 2017), DBRS views France’s external position as resilient and sustainable.

GRADUAL FISCAL CONSOLIDATION AND HIGH GOVERNMENT DEBT

Faced with a large structural deficit following the global crisis, successive administrations took a gradual approach to fiscal adjustment to support demand growth, while committing to a medium-term objective of structural fiscal balance. The 2017 general government deficit is expected to fall within the 3.0% of GDP Maastricht threshold for the first time since before the crisis. The government expects a more accelerated narrowing of the deficit over the medium-term. The deficit is forecasted to reach 2.8% of GDP in 2018, increase slightly to 2.9% in 2019 due in part to the cost associated with the one-off permanent decrease in employer social contributions, before narrowing to 1.5% in 2020.

The government’s consolidation strategy is to reduce public spending in structural terms. Public expenditures excluding tax credits are expected to remain below 55% of GDP in 2017. The government intends to reduce that figure to 51% of GDP by 2022. Risks to fiscal underperformance stem primarily from high social spending, which remains above the Eurozone average. Deterioration in the EC’s calculation of the structural deficit, from 2.4% of potential GDP in 2017 to 3.0% in 2019 in a no policy change scenario, illustrates the difficulty in making durable change to the French social protection model. Social spending is unlikely to decline significantly in the absence of additional policy measures or a considerable decrease in unemployment.

According to EC estimates, the general government debt reached 96.9% of GDP in 2017, where under current policies the EC expects it to remain through 2019. The government anticipates gross debt to fall to 91.4% of GDP by 2022. DBRS considers the high debt burden could eventually pose greater constraints on the French economy, as the European Central Bank (ECB) normalizes interest rates. Nonetheless, the French Treasury has a strong funding profile. Debt managers can count on a broad investor base and yields have remained at favourably low levels. Even in the current context of rising interest rates, DBRS expects the overall interest costs to increase only gradually due to the long debt maturity profile of 7.8 years for central government debt in 2017.

RISKS TO FINANCIAL STABILITY APPEAR MANAGABLE

The banking sector appears well positioned to support economic growth. Bank balance sheets have strengthened, and credit conditions remain broadly supportive of the economic recovery. Business credit is rising again at a healthy pace, while low domestic interest rates have helped spur a large wave of home loan refinancing. Banque de France’s data show household debt to disposable income increased to 91% in the third quarter 2017, from 70% a decade earlier. Debt outstanding of non-financial corporations increased to 72% of GDP, from 53% over the same period.

A main challenge for the French financial system has been to operate in an environment of low interest rates. The expected rise in interest rates is a welcome development for bank profitability. Bank margins have been squeezed by declining lending rates to households and corporates, in a context of regulated deposit rates. Then again, a sudden increase in interest rates could have negative effects on bank asset quality, stemming from the increase in private sector indebtedness. Risk is nevertheless limited by stable corporate leverage to equity ratios and improved capitalization of French banks.

RATING DRIVERS

The most immediate risk to the ratings from anti-EU sentiment was reduced last year following the presidential and parliamentary elections. Nonetheless, downside ratings pressure could emerge over the medium-term if significant adverse developments lead to renewed economic and financial stress, causing authorities to loosen fiscal discipline and reverse France’s gradually declining medium-term debt trajectory.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AAA to AA range. The main points discussed during the Rating Committee include economic performance, fiscal outcomes and the reform agenda.

KEY INDICATORS
Fiscal Balance (% GDP): -3.4 (2016); -2.8 (2017F); -2.8 (2018F)
Gross Debt (% GDP): 96.5 (2016); 96.9 (2017F); 96.9 (2018F)
Nominal GDP (EUR billions): 2,227 (2016); 2,289 (2017); 2,358 (2018F)
GDP per Capita (EUR): 34,441 (2016); 34,004 (2017); 34,888 (2018F)
Real GDP growth (%): 1.1 (2016); 2.0 (2017); 2.0 (2018F)
Consumer Price Inflation (%): 0.3 (2016); 1.2 (2017); 1.3 (2018F)
Domestic Credit (% GDP): 234.2 (2016); 237.7 (Sept-2017)
Current Account (% GDP): -0.9 (2016); -1.2 (2017); -1.2 (2018F)
International Investment Position (% GDP): -15.8 (2016); -24.4 (Sept-2017)
Gross External Debt (% GDP): 212.6 (2016); 214.6 (Sept-2017)
Governance Indicator (percentile rank): 89.9 (2016)
Human Development Index: 0.90 (2015)

Notes:
All figures are in Euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

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, World Bank, UNDP, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be 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 Sovereign Ratings
Initial Rating Date: May 12, 2011
Last Rating Date: September 29, 2017

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