DBRS Morningstar Confirms Republic of France at AA (high), Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of France’s Long-Term Foreign and Local Currency – Issuer Ratings at AA (high). At the same time, DBRS Morningstar confirmed the Republic of France’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trends on all ratings remain Stable.

KEY RATING CONSIDERATIONS
The Coronavirus Disease (COVID-19) pandemic has had a significant impact on the French economy and the country’s public finances but the economic recovery is now underway. A year ago, DBRS Morningstar downgraded France’s long-term ratings to AA (high) from AAA, to reflect the substantial economic deterioration related to the pandemic and its impact on France’s fiscal balance as well as the country’s already high debt metrics. France’s gross domestic product (GDP) declined by a large 8.0% in 2020, while the country’s fiscal deficit widened to 9.1%. Simultaneously, the country’s debt-to-GDP ratio increased to 115.0% at the end of last year, from 97.5% at the end of 2019. Although the COVID-19 shock has been significant for the French economy and its public finances, DBRS Morningstar points out that the strength of the economic rebound expected in 2021 and 2022 should support the government’s commitment to gradually rebalance the country’s public accounts over the medium-term.

The strong economic recovery so far this year reflects the improvement of the healthcare situation in France and in the rest of Europe, supported by the rapid rollout of the vaccination campaign and the lifting by the government of the most stringent restrictions imposed to contain the spread of the virus. Although some healthcare related uncertainty remains, particularly regarding the potential resurgence of vaccine resistant variants in coming quarters, the latest economic forecasts from the Banque de France currently anticipate France’s real GDP to rebound markedly this year, with an increase of 6.3% followed by a 3.7% growth in 2022.

The Stable trend primarily reflects DBRS Morningstar’s view that the French government remains fully committed to improving its medium-term fiscal trajectory once the COVID-19 crisis has passed. As a result, France’s ability to stabilise its debt-to-GDP ratio and subsequently place it on a firm downward trend will be key for the country to maintain its very strong credit profile.

France’s AA (high) ratings are underpinned by the country’s wealthy and diversified economy, strong public institutions, and financing flexibility. France benefits from a strong system of social protection which includes effective automatic stabilisers for the French economy and its households during crisis periods. Nevertheless, the country’s structurally high level of public expenditure-to-GDP, and the difficulty of the government to reduce it through reforms has historically made fiscal consolidation a complicated exercise. In addition, the country’s high public sector debt metrics, although benefiting from a reinforced affordability in recent years, continue to remain a source of vulnerability for France.

RATING DRIVERS
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 improve the trajectory of public sector debt.

RATING RATIONALE
The Impact of the Pandemic Has Been Significant but So is the Strength of the Recovery

The economic shock related to the COVID-19 pandemic has substantially affected France’s economic output last year. France’s real GDP contracted by 8.0% in 2020, more than the 6.3% decline recorded by the euro area. In 2021, France’s economic recovery is however expected to be strong, reflecting the improvement of the healthcare situation with a rapid rollout of the vaccination campaign over the last six months and the winding down of government restrictions. As of 11 October 2021, more than 75% of the French population had received at least one vaccine dose and 73% had been fully vaccinated.

The latest estimates from the Banque de France published in September 2021 foresee real GDP growth of 6.3% this year, supported by pent-up demand boosting household consumption, as well as strong corporate investment. France’s GDP should, therefore, come back to its pre-crisis level by the end of this year. For 2022, real GDP growth is forecast to decelerate to 3.7%, as the cyclical recovery loses steam. These forecasts are close to the government’s projections used to draft the 2022 budget of 6.0% growth in 2021 and 4.0% in 2022. While these projections remain clouded with uncertainty, particularly related to the healthcare situation, the downside risks appear to have somewhat receded in recent months. On this note, the recent rebound in inflation –particularly driven by the rise in energy prices– and whether it will affect domestic consumption, will remain a key focus in coming quarters. DBRS Morningstar nevertheless considers that the recent measures announced by the French government to mitigate the electricity and gas prices increase, which include an energy price freeze and a dedicated energy cheque, should support households’ purchasing power in the short-term.

The Negative Long-Term Effects of the Pandemic For the French Economy Appear Muted

DBRS Morningstar expects the long-term output loss related to the COVID-19 crisis to remain limited for the French economy, primarily reflecting the substantial support provided by the government to mitigate the structural impact of the crisis on firms and households. The labour market has for instance been almost fully insulated from the adverse effects of the crisis, benefiting from unemployment and job support schemes. Recent forecasts from the French statistical office INSEE suggest that France’s unemployment rate will likely reach 7.6% at the end of 2021, below the level of 8.1% recorded at the end of 2019 and substantially lower than the level of 9.6% recorded on average between 2010 and 2019.

Similarly, thanks to government support measures, the level of corporate bankruptcies has also decreased significantly over the last two years. At the end of August 2021, the cumulated number of bankruptcies over a 12-month period was 47% below the level recorded in the 12 months leading to August 2019. This partly reflected the government’s loan guarantee scheme put in place to support firms’ liquidity, which led to the provision of EUR 142 billion of loans as of 1 September 2021 to more than 680,000 primarily small and medium sized enterprises (SMEs) as well as additional support measures to the most affected sectors through the Solidarity Fund (a financial compensation to businesses) or loans moratoria. While DBRS Morningstar considers that the number of bankruptcies is likely to increase in coming quarters as government support winds down, the negative effects of the COVID-19 pandemic on both the labour market and the overall private sector should remain limited.

Deficits Widened Significantly but the Recovery Should Support the Gradual Rebalancing of Fiscal Accounts

France’s fiscal position, in line with European and international peers, deteriorated significantly in 2020, reflecting the financial support implemented by the national government to mitigate the impact of the economic shock on firms and households. The French deficit reached 9.1% of GDP last year, much larger than the 3.1% deficit recorded at the end of 2019. For 2021, the latest government estimate is for a deficit of 8.4% of GDP, still wide but slightly improved from six months ago when it was expected to reach 9.0% of GDP. The fiscal deficit continues to be primarily driven by the exceptional support measures taken by the government, as well as its economic recovery plan (“France Relance”). This plan corresponds to an additional EUR 100 billion (around 4% of GDP), comprising new expenditures and a reduction in taxes, expected to be fully committed by the end of 2022. At the end of August 2021, already EUR 47 billion had been committed, with a target of EUR 70 billion by the end of this year. This additional fiscal stimulus is expected to be partly financed by grants stemming from the Next Generation EU (NGEU) programme. France’s grant allocation under the Recovery and Resilience Facility (RRF) should represent close to EUR 40 billion, or 40% of the plan’s overall size.

DBRS Morningstar views positively the economic recovery plan as it allows for immediate support to households and businesses affected by the pandemic and should reinforce job creation and economic activity. The plan has three pillars: EUR 36 billion for healthcare, employment and training; EUR 34 billion to boost corporate competitiveness by reducing taxation (including EUR 10 billion in production tax reduction already implemented) and supporting investment; and EUR 30 billion targeting the government’s ecological objectives. In addition, the French President announced on 12 October 2021 a complementary investment plan (“France 2030”) representing an additional EUR 30 billion to be spent over five years from 2022 and aiming at developing the country’s industrial competitiveness as well as new technologies.

Over the medium-term, the French government expects the fiscal trajectory to improve gradually, with the deficit declining below 3% of GDP by 2027. In 2022, the deficit is already expected to decrease markedly, to 4.8% of GDP, but this improvement will likely mostly reflect cyclical factors. Please refer to DBRS Morningstar’s Commentary: France 2022 Budget: Cyclical Improvement But Structural Challenges Remain for more information. Tackling structural imbalances while avoiding social protests will remain a key challenge for the government going forward. DBRS Morningstar’s focus will therefore remain on the credibility of the government’s plan to rebalance its fiscal accounts, and on the resumption of its structural reform programme. On that note, while the unemployment insurance reform should be fully operational in coming months, the implementation of the pension reform –for which the format still has to be clarified– is likely to be postponed until after the presidential and legislative elections next year. In DBRS Morningstar’s view, rebalancing the fiscal accounts and stabilising the debt ratio will remain key for France to maintain its strong credit profile going forward.

After the Large but Affordable Increase in Debt Last Year, France’s Debt Ratio Set to Peak this year

France’s debt-to-GDP ratio increased significantly last year, reaching 115.0%, up from 97.5% in 2019. This increase reflected the joint effects of the large financing deficit and economic contraction. This year, as the economy recover, the government expects the public debt ratio to only marginally increase to 115.6% of GDP before slightly decreasing to 114% in 2022. Over the medium-term, the debt is expected to broadly stabilise at close to this high level before starting to decline. France is also implementing a specific COVID-19 debt amortisation scheme to repay over 20 years the COVID-19 related debt, estimated at EUR 165 billion, starting in 2022. While reducing the structural deficit will remain a key focus for DBRS Morningstar going forward, the government’s commitment to reduce its debt levels over time remains important for the country’s creditworthiness.

The country’s high debt metrics expose France to future increases in interest rates, but DBRS Morningstar considers that any rise in rates, should it materialise, should be gradual. France’s strong financing conditions in 2020 and so far in 2021 also support the country’s debt profile. This is exemplified by the negative average financing rate on the government’s issuances in the last 18 months and the very low average cost of the French government’s debt at 1.3%, its lowest historical level. These very good financing conditions have been supported by the European Central Bank’s (ECB) asset purchase programme as well as the pandemic emergency purchase programme (PEPP). The French Treasury, through its prudent debt management strategy also took advantage of these favourable financing conditions to continue to extend its debt maturity profile, with an average maturity at the end of August 2021 of 8.4 years, increasing from close to 7.0 years in 2014. The strong financing conditions support DBRS Morningstar’s positive assessment of the “Debt Management and Liquidity” building block.

Implementing Additional Structural Reforms Before The 2022 National Elections Appears Unlikely

The government has so far effectively managed to mitigate the shock of the COVID-19 disease on French households and firms. Nevertheless, the pandemic contributed to a pause in the government’s ambitious reform agenda that it had set for the last years of its mandate. Although additional tax breaks for households and firms are taking place in 2021 and 2022 –including the decrease in the corporate tax rate to 25% or the EUR 10 billion cut in production taxes– and the unemployment insurance reform is currently being implemented, the delivery of the pension reform has been again postponed. With French presidential elections scheduled to take place on the 10th of April 2022 for the first round and on the 24th of April for the second round, followed by Parliamentary elections (French lower house, which sets the government majority) on the 12th and 19th of June 2022; further key reforms appear unlikely in coming months. DBRS Morningstar will monitor the political programmes and agendas of future presidential candidates, particularly with regards to key themes including France’s euro area membership as well as candidates’ commitment to medium-term fiscal consolidation to assess their potential impact on France’s credit profile.

The French Banking Sector Is Resilient, Challenges Could Arise But They Should Remain Manageable

The French banking sector delivered a resilient performance throughout the COVID-19 shock. At end-June 2021, French banks were well capitalised with comfortable capital buffers (CET1 ratio at 15.9% according to ECB data), and low non-performing loan (NPL) ratios, at 2.1%. Although French banks benefit from strong diversification and balance sheet positions, DBRS Morningstar still expects a deterioration in banks’ asset quality in the coming quarters, as support measures from the government continue to be lifted. This deterioration should nevertheless remain concentrated in the sectors most affected by the pandemic, and hence, should remain manageable for the banking sector, although the risks are to the downside.

The surge in credit growth to non-financial corporations (NFCs) since the beginning of 2020 (+12.5% at the end of July 2021) largely reflected the degree of uncertainty related to the healthcare situation and the strong access to liquidity for firms, supported by the provision of guaranteed loans by the government. The proceeds of these loans were, therefore, primarily used by NFCs to finance working capital during the lockdowns, but also as precautionary savings, adding to cash buffers. The Banque de France estimates that gross debt of NFCs increased by EUR 210 billion between December 2019 and July 2021, while their cash reserves increased broadly in parallel by EUR 207 billion, implying a level of net debt flat since the beginning of the crisis. For households, excess savings since the beginning of 2020 were also very significant, with an estimate at around EUR 157 billion in June 2021. DBRS Morningstar’s view that some of the deterioration in credit and property price metrics from its scorecard are likely temporary – positively influences its “Monetary Policy and Financial Stability” building block assessment.

France’s External Accounts Have Also Been Affected By The Pandemic

France’s current account deficit is estimated to have widened last year to 1.9% of GDP from a deficit of 0.3% of GDP in 2019, largely reflecting the impact of the pandemic on the tourism sector and the 45.5% decline in exports from the aeronautics industry (representing 13% of 2019 exports), particularly affected by the crisis. DBRS Morningstar nevertheless considers that the deterioration in the current account largely reflected the exceptional healthcare situation with its related containment measures and travel restrictions and is therefore unlikely to become structural, although uncertainties exist as to future demand for air transport. DBRS Morningstar continues to take the view that France has no material external imbalances and could benefit from the rapid improvement of the external environment in in the next few years. The recent increase in energy prices as well as some supply chain constraints represent a downside risk but they are unlikely to fully impede the improvement in France’s current account balance in the short-term. The country’s open economy with extensive trade, investment, and financial linkages throughout Europe and globally continue to support DBRS Morningstar’s positive qualitative assessment of the “Balance of Payments” building block.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/386009.

EURO AREA RISK CATEGORY: LOW

Notes:
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

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 https://www.dbrsmorningstar.com/research/381451/global-methodology-for-rating-sovereign-governments (July 9, 2021). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).

The sources of information used for this rating include Ministry of Economy and Finance (Budget 2022, September 2021), French Stability Programme (April 2021), National Institute of Statistics and Economic Studies (INSEE), Banque de France (Macroeconomic Projections, September 2021; Annual Report on France’s Balance of Payment, July 2021), Agence France Tresor, High Council on Public Finances, Eurostat, International Monetary Fund (World Economic Outlook, October 2021; 2020 Article IV Consultation, January 2021), World Bank, Bank for International Settlements (BIS), OECD, United Nations Development Programme (UNDP), Haver Analytics, Social Progress Imperative (2020 Social Progress Index), 2019 Global Competitiveness Report from the World Economic Forum. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit 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: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/386010.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Nicolas Fintzel, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James; Managing Director, Co-Head Global Sovereign Ratings
Initial Rating Date: May 12, 2011
Last Rating Date: April 16, 2021

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