DBRS Ratings GmbH (DBRS Morningstar) downgraded the Republic of France’s Long-Term Foreign and Local Currency – Issuer Ratings to AA (high) and changed the trend to Stable from Negative. At the same time, DBRS Morningstar confirmed the Republic of France’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high) and maintained the trend at Stable.
KEY RATING CONSIDERATIONS
The downgrade reflects DBRS Morningstar’s view that the material deterioration to France’s medium-term outlook and to its public finances, as a result of the global health and economic crisis, causes the country’s credit metrics to no longer align with AAA ratings. The spread of the novel Coronavirus Disease (COVID-19) compounds France’s existing credit challenges, including structurally high public sector expenditures and debt. The country arrived to the crisis with a comparatively weaker fiscal position than most of its AAA-rated peers. While the debt-to-GDP ratio stabilized over the last few years, France had been unable to steer its trajectory downwards. Furthermore, the COVID-19 shock complicated the government’s plan to return to medium-term fiscal balance and caused it to delay remaining parts of its reform agenda. Deterioration of DBRS Morningstar’s “Fiscal Management and Policy” and “Economic Structure and Performance” building blocks led to the rating changes.
France’s AA (high) ratings are underpinned by its wealthy and diversified economy, strong public institutions, and financing flexibility. The negative yield on French bonds out to 15-years demonstrates the country’s excellent financing conditions. Despite favourable funding terms to combat the crisis, the pandemic will add to the already high stock of public sector debt this year. The government projects its 2020 fiscal deficit to increase above 10% of GDP and its public debt ratio to reach 118%. DBRS Morningstar expects only a gradual repair to public finances in the coming years.
The Stable trend reflects France’s sizable response to the crisis that should, in DBRS Morningstar’s view, lessen crisis-related difficulties in the months to come and may overtime improve growth prospects. The government responded to the pandemic with a series of large fiscal aid packages to protect households, businesses, and the health system. The Recovery Plan as part of the 2021 Budget is set to allocate an additional EUR 100 billion over two years with the aim to (1) stimulate near-term growth, mainly in the form of job support measures; and (2) strengthen medium-term prospects, via tax cuts and supply-side investments to boost competitiveness and accelerate the ecological transition.
The ratings could be upgraded if future fiscal consolidation of the public balance sheet is faster and more durable than currently expected; or if the policy response to the crisis significantly improves the productive capacity of the economy.
The ratings could be downgraded if the government takes significantly longer than is currently expected to repair the medium-term fiscal outlook or reverse the trajectory of public sector debt dynamics.
The COVID-19 Crisis Brings About a Large Contraction of the French Economy
The health crisis and the subsequent restrictions have imposed a serious cost on the French economy. Confinement measures starting in March 2020 meant to slow disease transmission led to a 13.8% decline of the economy in the second quarter compared with the first quarter. All expenditure components were severely affected. The economy recovered sharply in the third quarter, with the easing of mobility restrictions in May 2020 and thanks to generous unemployment and job support programs as well as pent up demand from an increase in private savings. Nonetheless, the virus continues to circulate. Identified COVID-19 cases in early October 2020 increased above levels seen in the Spring, leading to a re-escalation of restrictions. As a result, the pace of the economic recovery is unclear.
The government expects output to contract by 10.0% in 2020, before a strong 8.0% rebound in 2021. Growth projections are subject to considerable risk, both in the near-term and over a longer time horizon. In the coming months, there are still significant uncertainties around the evolution of the virus. A persistent rise in infections and COVID-related deaths would inevitably result in further restrictive policy measures. Likewise, the economic consequences of the shock may prove more long-lasting than originally envisaged. Although emergency government measures are designed to try and preserve businesses, jobs, and income, adverse second round effects could still emerge following the crisis, as firms contract and households deal with higher unemployment.
France’s external performance will depend on the progression of the virus and demand conditions among key trading partners. The external sector is already being affected by the current crisis, given the country’s large tourist sector and its share of exports in the aerospace sector (13% of 2019 exports). How the Brexit negotiations are ultimately settled, and the nature of the future trade relationship between France and the UK will also likely affect external performance. That said, France has no noticeable external imbalances. The country’s open economy with extensive trade, investment, and financial linkages throughout Europe and around the world support DBRS Morningstar’s positive qualitative assessment of the “Balance of Payments” building block.
Large Expansionary Fiscal Policy Will Result in Wide Fiscal Deficits in 2020 and 2021
France’s fiscal position had not yet fully rebalanced at the onset of the COVID-19 crisis. Numerous tax cuts and other spending amendments were included in the 2018 and 2019 budget bills in response to “yellow vest” protests. Public spending remained high at 54% of GDP in 2019, despite healthy economic performance and the significant decline in debt servicing costs. France’s fiscal deficit was 3.0% of GDP in 2019, or 2.1% excluding the one-off transformation of the CICE tax credit into reduced employer contributions. At the start of 2020, DBRS Morningstar expected a continuation of the slow budget consolidation that has occurred over the course of the last decade.
The outbreak of the pandemic and the economic implications for France have radically changed the country’s fiscal outlook, as it has for many countries. To counter the adverse effects of the virus on the economy, the government has passed three supplementary budget laws since March 2020. Taken together, the three sizable packages consist of around EUR 140 billion (5.8% of GDP) to be directed towards increased health spending, partial unemployment, support to households, deferrals of corporate taxes and social contributions, and liquidity measures to businesses. EUR 64.5 billion (2.9% of GDP) will have a direct fiscal impulse. The government also made available over EUR 300 billion of government guarantees to corporates through the end of the year, of which EUR 120 billion has already been extended. In addition, the government announced in September 2020 an additional EUR 100 billion (4.1% of GDP) 2020-22 economic recovery plan. Assumptions from the 2021 Budget now project the deficit to reach 10.2% of GDP in 2020 and narrow to 6.7% in 2021.
In DBRS Morningstar’s view, the recent economic recovery plan provides immediate spending to support households and businesses affected by the pandemic along with supply-side measures to support future job creation and economic activity. The plan has three pillars: EUR 36 billion towards healthcare infrastructure and to support employment and via protection schemes and active labour market policies; EUR 34 billion to boost corporate competitiveness by reducing taxation and supporting investment; and EUR 30 billion towards the government’s ecological objectives. While this plan could spur future productivity gains, the government expects the plan will be 40% funded by the EU Recovery Fund (NextGenerationEU) – the full details of which are not yet available.
Public Debt Set to Increase by Almost Twenty Percentage Points of GDP in 2020; Debt Servicing to Remain Affordable
At 98.1% of GDP in 2019, France’s debt ratio has been broadly stable over the last few years, but the COVID-19 crisis will cause a sharp upward shift this year. The government expects the ratio to reach 117.5% in 2020 and decline slightly to 116.2% in 2021. The IMF projects the ratio to rise to 123% by 2025. These forecasts depend on how the crisis unfolds and are subject to considerable revision. On the downside, contingent liability risks to the government balance sheet could materialize from calls on loan guarantees or if the sovereign is called upon to support large corporates. In DBRS Morningstar’s view, the rapid rise in public debt makes the currently low debt servicing costs vulnerable to future increases in interest rates and could over time reduce the governments capacity to absorb future shocks.
France’s debt ratio will likely remain for the foreseeable future among the highest in its AA-rated peer group. Nonetheless, ECB policy and France’s prudent debt management strategy help mitigate risk associated with high public debt. France’s position in Europe and accommodative monetary policy provides the Treasury with substantial funding flexibility that allows it to maintain a higher level of indebtedness at low costs. The State’s excellent financing ability in 2020 is reflected by the -0.11% average interest rate on medium and long term bonds. The treasury has taken advantage of these conditions to issue longer-term debt, increasing the average maturities of its bonds to 11 years. The healthy financing condition supports DBRS Morningstar’s positive assessment of the “Debt Management and Liquidity” building block.
The French Banking Sector is Resilient, But Will Also Be Challenged by the Current Crisis
The French banking sector delivered a resilient performance in 2019. Profitable and well capitalized, the Banks started the year well positioned to support economic growth. A main challenge for the French financial system prior to the crisis had been for banks to operate in an environment of low interest rates. The current economic shock further complicates the environment. Despite the French banks’ strong diversification and balance sheets, DBRS Morningstar expects the banks to suffer a deterioration in profitability and asset quality in the coming quarters (see commentary French Banks: 2020 Outlook Looks Increasingly Challenging).
The Global Health and Economic Crisis has Upended Policy Priorities in France
The spread of COVID-19 has imposed a tragic human cost and has caused the government to reorient its priorities. As of October 16, 2020, the virus has claimed nearly 33,000 lives in France, and after suppression of the transmission curve during the summer months the number of people diagnosed as positive reached the highest levels since the start of the outbreak. To slow the proliferation of the virus once again, the government in September 2020 announced alert thresholds and re-introduced local restrictions. The government’s extraordinary policy measures to try and cushion the health and economic consequences of the pandemic best illustrate government effectiveness. France is a strong performer on World Bank governance indicators. As attention turned to the crisis, the government delayed parts of its reform agenda. Pending reforms to the pension system and additional changes to the unemployment insurance system, DBRS Morningstar had expected delivery of both in 2020, have understandably been deferred at least until next year.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments.
EURO AREA RISK CATEGORY: LOW
All figures are in Euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified.
The principal methodology is the Global Methodology for Rating Sovereign Governments (July 27, 2020) https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
The sources of information used for this rating include Ministry of Economy and Finance (Budget 2021, September 2020), National Institute of Statistics and Economic Studies (INSEE), Banque de France (Macroeconomic Projections, September 2020), Agence France Tresor, High Council on Public Finances, Eurostat, International Monetary Fund (World Economic Outlook, October 2020), World Bank, Bank for International Settlements (BIS), United Nations Development Programme (UNDP), Haver Analytics. DBRS Morningstar 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.
With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO
DBRS Morningstar 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 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.
For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see:
The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/368418
Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.
Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Credit Ratings
Initial Rating Date: May 12, 2011
Last Rating Date: April 17, 2020
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