DBRS Confirms Republic of France at AAA, Stable Trend

DBRS Ratings Limited 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 trends on all ratings are Stable.

KEY RATING CONSIDERATIONS

The ratings confirmation is underpinned by the government’s clear commitment to improving the country’s macroeconomic outcomes. DBRS expects the Macron government to continue its push to implement ambitious structural reforms, while keeping France committed to reaching its medium-term fiscal balance objective and to lowering the public-sector debt burden. Despite a slight slowdown in the first quarter of 2018, the cyclical economic recovery across Europe and the private sector confidence boost from the government’s economic policy agenda continue to create a favourable growth environment.

The country’s strengths are balanced by high public-sector debt and still high measures of unemployment. France’s debt ratio is expected to have peaked at 97.0% of GDP last year. While progress in the labour market is evident by the decline in France’s harmonised seasonally-adjusted unemployment rate to 8.8% in March 2018, from 9.6% in August 2017, the rate remains above the European Union’s (EU) aggregate of 7.1% in March 2018. The high debt burden limits the country’s ability to respond to future shocks, and persistently high unemployment carries fiscal and social costs and can have lasting effects on productivity.

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 economic and financial stress, causing authorities to loosen fiscal discipline and reverse France’s plan to reduce the debt-to-GDP ratio.

RATING RATIONALE

Domestic and External Economic Indicators Remain Strong, Despite a Slow First Quarter

DBRS considers that the slowdown in activity in the first quarter and ongoing second quarter railway transportation labour disruptions are unlikely to dampen France’s favourable growth environment. The new administration launched its ambitious agenda to reform the labour market and strengthen budgetary performance shortly after taking office in mid-2017. Last September, the authorities built on the previous labour market changes by reforming the labour code, and budget adjustments were made during the second half of last year to comply with Maastricht thresholds. Both strengthened business-sector confidence. Strong 2.0% growth in 2017, up from 1.1% in 2016 according to government estimates, reflects optimism in the cyclical global economic upswing and domestic supply-side reforms.

Reform momentum has continued this year, with initiatives to reform professional training and the national railway system, Société Nationale des Chemins de fer Français (SNCF). Apprenticeship and unemployment insurance reforms have been presented to the Council of Ministers in 2018. Proposed change to SNCF worker status has predictably been met with resistance. Notwithstanding the disruptions, consensus forecasts are for economic growth of 2.1% this year and 1.9% 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. The long-term decline in France’s global export share reflects the competition challenge faced by all developed countries over the last two decades from emerging economies and some France-specific competitiveness challenges. Yet, French export shares have stabilised since 2012 and the total volume of French exports, at €658 billion in 2017, is at an all-time high. With manageable 2017 deficits as a share of GDP in the current account balance (0.6% according to recently revised Banque de France data) and the international investment position (20.1%), DBRS views France’s external position as resilient and sustainable.

Government Debt May Have Peaked Last Year, Following a More Rapid Fiscal Consolidation Effort in 2017

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 fiscal balance. Fiscal consolidation accelerated last year, primarily due to revenue overperformance from a strong economic recovery. The general government deficit narrowed to 2.6% of GDP in 2017, within the Maastricht threshold for the first time in a decade. The government expects the deficit to reach 2.3% of GDP in 2018 and increase to 2.4% in 2019 due to the permanent decrease in employer social contributions, creating a one-off cost to the government of roughly 1 percentage point of GDP. The deficit net of the one-off is estimated around 1.5% in 2019, before narrowing to 0.9% in 2020.

The government’s consolidation strategy over the medium-term is to reduce public spending as a share of GDP. Public expenditure, excluding tax credits, was 55.1% of GDP in 2017. The government intends to reduce that figure to 51.1% 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 in a no policy change basis, from 2.1% of potential GDP in 2017 to 3.1% in 2019, illustrates the persistent cost pressures to the French social protection model in the absence of policy change or a significant reduction in unemployment. To meet expenditure targets, the multiyear Public Finance Plan Law for 2018-2022 aims to reduce the growth rate of public spending in real terms.

According to the government’s Stability Programme, general government debt is expected to have peaked at 97.0% of GDP in 2017. The government anticipates the debt ratio to fall to 94.7% in 2020 and to 89.2% by 2022. While DBRS is encouraged by the aggressive debt reduction targets, France’s debt ratio remains among the highest in its peer group. The high debt stock could eventually pose constraints on the French economy, as the European Central Bank normalises interest rates. However, 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 context of rising medium-term interest rates, stress testing shows the downward debt trajectory resilient to shock scenarios. DBRS expects interest costs to increase only gradually due to the long debt maturity profile of 7.8 years for central government debt as of early 2018.

Risks to Financial Stability Appear Manageable

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. Latest available Banque de France 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. The indebtedness ratio for non-financial corporates net of cash flows and loans to foreign affiliates appears more contained, around 45% of GDP, and it has remained broadly steady over the last decade.

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 over the medium-term. 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 leverage to equity ratios in the corporate sector and solid capitalisation of French banks.

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): -2.6 (2017); -2.3 (2018F); -2.8 (2019F)
Gross Debt (% GDP): 97.0 (2017); 96.4 (2018F); 96.0 (2019F)
Nominal GDP (EUR billions): 2,290 (2017); 2,358 (2018F); 2,433 (2019F)
GDP per Capita (EUR): 34,004 (2017); 34,888 (2018F); 35,803 (2019F)
Real GDP growth (%): 1.8 (2017); 2.0 (2018F); 1.8 (2019F)
Consumer Price Inflation (%): 1.2 (2017); 1.7 (2018F); 1.4 (2019F)
Domestic Credit (% GDP): 235.2 (2016); 238.6 (2017)
Current Account (% GDP): -3.0 (2017); -2.9 (2018F); -2.7 (2019F)
International Investment Position (% GDP): -14.9 (2016); -20.1 (2017)
Gross External Debt (% GDP): 213.7 (2016); 210.9 (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 above European Commission estimates for the current account deficit do not reflect Banque de France data revision released in April 2018. The current account deficit was 0.6% in 2017 according to the revision.

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:
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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: March 16, 2018

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