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 COVID-19 pandemic has significantly affected the French economy and its public finances, but the recovery in 2021 was strong, outperforming many European peers, and has allowed the government to commence the gradual rebalancing of its public sector accounts. The economic outlook remains nevertheless clouded with uncertainty related to the pandemic and inflation, largely prompted by the surge in energy prices. The impact of Russia’s invasion of Ukraine is likely to keep inflation high in the foreseeable future, weighing on households’ purchasing power and ultimately affecting growth prospects. Similarly, while additional fiscal measures implemented by the government to smooth the pass-through of inflation to firms and households could support consumption and investment in the short-term, they could, particularly if protracted and expanded, delay the fiscal accounts’ rebalancing.

The Stable trend reflects DBRS Morningstar’s view that despite additional economic challenges, the French government remains fully committed to improving its medium-term fiscal trajectory. Ahead of the upcoming elections, DBRS Morningstar takes the view that this commitment will remain a focus point of the future French government. France’s ability to stabilise its debt-to-GDP ratio and subsequently place it on a firm downward trend will remain key determinants 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, making the French economy and its households more resilient during crisis periods. This leads the country to have a structurally higher level of public expenditure-to-GDP which has historically proved difficult to reduce, making fiscal rebalancing more challenging. 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 fiscal consolidation of the public balance sheet is faster and more durable than currently expected; or if policy measures and reforms significantly improve 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 to improve the trajectory of the public sector debt.

RATING RATIONALE

Risks of Long-Term Economic Scarring from the Pandemic Recede but Rising Inflation Keeps Uncertainty High

Following the large economic shock related to the COVID-19 pandemic in 2020, with gross domestic product (GDP) contracting by 8.0%, the French economy rebounded strongly in 2021. Real GDP is estimated to have increased by 7.0% last year, above earlier estimates and outperforming the Euro area growth rate of 5.3%. The strong recovery, underpinned by the improvement of the healthcare situation and less stringent government restrictions, reflected the pick-up in public and household consumption during the year as well as the significant rise in investment. As a result of this solid rebound, French GDP had recovered its 2019 level by the end of the third quarter of 2021. The swift rebound last year together with the continued support provided by the government to mitigate the structural impact of the pandemic were also key factors driving the solid performance of the French labour market. At the end of 2021, employment was at its highest historically recorded level while the unemployment rate reached 7.4%, below its pre-crisis level of 8.1%, and much lower than the level of 9.6% recorded on average between 2010 and 2019.

In 2022, although decelerating, the French economy is expected to continue to grow above potential, with the forecasts from the Banque de France from mid-March anticipating GDP growth between 2.8% and 3.4%, depending on the reference scenario. For 2023, growth is expected to be between 1.3% and 2.0%. The two scenarios factor in different assumptions regarding energy prices and levels of uncertainty related to the situation in Ukraine. The economic growth outlook for this year and next remains clouded with uncertainties, particularly related to the future evolution of energy and commodity prices and their potential impact on the recovery. DBRS Morningstar points out that while economic prospects are likely to remain affected by inflationary pressures over the next 12-to-24 months, inflation figures in France have so far fared better than for many of its European peers. At the end of February 2022, annual HICP inflation reached 4.2% in France compared with 5.9% in the Euro area and 6.2% in the European Union. DBRS Morningstar considers that France’s inflation level may have benefited from the early support measures implemented by the French government to limit the energy prices increase for households as well as from the comparatively lower reliance of the French energy mix on natural gas, particularly sourced from Russia. Going forward, the possible pass through of inflationary pressures to wages and core inflation will remain key focus points to assess their potential long lasting impact on the economic outlook.

Upcoming Elections Are Unlikely to Derail The Government’s Commitment to Fiscal Rebalancing

French presidential elections, scheduled for the 10th of April for the first round and the 24th of April for the second round, followed by Parliamentary elections –French lower house, which sets the government majority– currently scheduled for the 12th and 19th of June 2022, will be key to set out France’s future medium-term fiscal and economic policies. DBRS Morningstar takes the view that the future government is likely to maintain broad policy continuity and commitment to the gradual rebalancing of fiscal accounts, a key supportive feature of France’s credit profile. Incumbent President Macron (La Republique En Marche) currently leads the polls from IFOP as of the 28th of March 2022 for the first round, at 28% of voting intentions, ahead of Le Pen from the far-right Rassemblement National at 21%. They are followed by Mélenchon from far-left party La France Insoumise polling at 14%, Pécresse from center-right Les Républicains and Zemmour from the newly formed far-right party Reconquête, both at 11% of voting intentions. In a hypothetical second round of elections, latest polls indicate that incumbent President Macron would be re-elected over contender Le Pen.

Following the presidential election, DBRS Morningstar will also focus its attention on the legislative elections. Maintaining a sound Parliamentary majority will remain key for the future President to be able to implement its policy and reform agendas. The potential lack of a Parliamentary majority that would complicate or significantly delay the delivery of meaningful reforms could weigh negatively on France’s ability to restore its fiscal accounts over the medium-term, a credit negative.

Large Deficits Related to the Pandemic but the Recovery is Supporting the Gradual Rebalancing of Fiscal Accounts

France’s fiscal position deteriorated significantly in 2020, with a deficit of 8.9% of GDP, increasing from a deficit of 3.1% in 2019. This deterioration primarily reflected the financial support implemented by the national government to mitigate the impact of the economic shock on firms and households. In 2021, the deficit is estimated to have started its decline, to 6.5% of GDP, still wide but markedly improved compared with earlier budgetary projections of a deficit of up to 9.4%. The fiscal deficit continued to be 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 2021, EUR 72 billion had already been committed, a feature likely to have supported France’s above average economic recovery last year. This additional fiscal stimulus focusing on ecology, corporate competitiveness and cohesion via healthcare, employment and training support, will be partly financed by grants stemming from the Next Generation EU (NGEU) programme. France’s current grant allocation under the Recovery and Resilience Facility (RRF) represents close to EUR 40 billion, or 40% of the plan’s overall size, of which EUR 12.5 billion have already been received.

DBRS Morningstar views positively France’s rapid implementation of its economic recovery plan as it allowed for immediate support to households and businesses affected by the pandemic and is likely to reinforce job creation and economic activity. In addition, France announced a complementary investment plan (“France 2030”) at the end of last year, representing an additional EUR 34 billion to be spent over five years from 2022 and aiming at developing the country’s industrial competitiveness as well as new technologies. In March 2022, the French Prime Minister also announced a new Economic and Social Resilience Plan, aimed at limiting the impact on households and firms of the energy prices surge heightened by the war in Ukraine. The cost associated with this plan and the previous measures already adopted to protect households from inflation is currently estimated at more than EUR 22 billion or close to 1% of GDP and is likely to evolve in coming months in line with energy prices.

While these measures should help to somewhat smooth the impact of higher energy prices on households and businesses, they may, together with the weakening of the macroeconomic environment, challenge the government’s target of a deficit of 5.0% of GDP in 2022. Over the medium-term, the government’s fiscal trajectory foresees a gradual improvement of the deficit, to a level below 3% of GDP by 2027. DBRS Morningstar takes the view that the upcoming elections and the unfavourable external environment could possibly affect the timing associated with this downward trajectory, but that overall, the future government would remain committed to medium-term fiscal rebalancing. In that context, tackling structural imbalances while avoiding social protests will remain a key challenge for the next government. DBRS Morningstar’s focus will therefore remain on the credibility of the future government’s plan to rebalance its fiscal accounts as well as on its structural reform programme.

After the Strong Debt Increase Associated with the Pandemic, Debt is Currently Expected to Stabilise before Declining

France’s public sector debt-to-GDP ratio increased significantly in 2020, reaching 115.0%, up from 97.5% in 2019. This increase reflected the joint effects of the large financing deficit and economic contraction. In 2021, in line with the economic recovery, the government expects the public debt ratio to have slightly declined to 112.9%. Over the medium-term, subject to the new government’s fiscal plan and to the evolution of the macroeconomic environment, the debt ratio should broadly stabilise before starting to decline. In line with the reduction in the headline deficit, the government’s commitment to reduce its debt levels over time will remain critical for DBRS Morningstar’s assessment of the country’s creditworthiness.

The country’s high debt metrics remain a vulnerability for France as it exposes the country to future rapid increases in interest rates. Despite the rise in inflation in recent months, DBRS Morningstar continues to consider that any increase in interest rates should remain gradual. France’s strong financing conditions and financing flexibility also continue to support the country’s debt profile. This is exemplified by the negative average financing rate on the government’s issuances throughout 2020 and 2021 and the very low average cost of the French government’s debt at 1.46% at the end of 2021. 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 2021 of 8.4 years, increasing from close to 7.0 years in 2014. The strong financing conditions support DBRS Morningstar’s positive qualitative adjustment for the “Debt Management and Liquidity” building block.

The French Banking Sector Is Resilient and Challenges Should Remain Manageable

The French banking sector delivered a strong performance throughout the COVID-19 shock. At end-September 2021, French banks were well capitalised with comfortable capital buffers (CET1 ratio at 15.8% according to ECB data), and low non-performing loan (NPL) ratios, at 2.0%. Although French banks benefit from strong diversification and balance sheet positions, DBRS Morningstar still expects some pressure to build up on banks’ asset quality in the coming quarters, possibly exacerbated by the recent increase in geopolitical tensions. The cost of risk for the banking sector could therefore be affected, reflecting the likely macroeconomic impact of the Russian invasion of Ukraine and the surge in energy and commodity prices. This is likely to lead French banks, particularly those with subsidiaries and/or cross-border exposures to Russia to book higher provisions compared to 2021, although overall, these are likely to remain below their 2020 levels, and the deterioration should remain manageable. Please refer to DBRS Morningstar’s Commentary: European Banks’ Direct Exposure to Russia and Ukraine Is Manageable, But Risks Have Increased (16 March 2022) for additional information.

The gross debt increase of non-financial corporations (NFCs) since the beginning of 2020 (+15.8% at the end of January 2022) 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 Banque de France estimates that gross debt of NFCs increased by EUR 265 billion between December 2019 and January 2022, while their cash reserves increased by EUR 218 billion, implying a level of net debt only marginally higher since the beginning of the pandemic. For households, excess savings since the beginning of 2020 were also very significant, with an estimate at around EUR 175 billion at the end of 2021. DBRS Morningstar’s view that some of the deterioration in credit and property price metrics from its scorecard are likely temporary – continues to positively influence its “Monetary Policy and Financial Stability” building block assessment.

Short-Term Outlook for France’s External Accounts Remains Weak Given the Current Shock on Commodity Prices

France’s current account deficit is estimated to have remained negative in 2021, at around 1.0% of GDP according to the latest data from the Banque de France, reduced compared with the deficit of 1.9% of GDP recorded in 2020. The weaker current account balance over the last two years, compared with the negative position of 0.3% of GDP in 2019, largely reflected the impact of the pandemic on (1) the tourism sector in 2020; (2) the goods deficit with the decline in exports from the aeronautics and automobile industries; and (3) the increase in energy prices last year. The latter was largely compensated in 2021 by the increase in the services surplus driven by the recovery of travel and business services. While DBRS Morningstar continues to consider France’s weaker current account balance in 2020 and 2021 as largely cyclical, higher energy prices throughout 2022 are likely to continue to weigh on France’s external accounts. France’s exposure to Russia as a trade partner is limited, given that Russia represented about 1% of French exports and imports in 2020. DBRS Morningstar continues to take the view that France has no material external imbalances and could benefit from a normalisation of the external environment over the medium-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 adjustment for 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/394734.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in Euros (EUR) 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, October 2021), National Institute of Statistics and Economic Studies (INSEE), Banque de France (Macroeconomic Projections, March 2022; Annual Report on France’s Balance of Payment, July 2021 and December 2021 Report from February 2022), Agence France Tresor, High Council on Public Finances, Eurostat, European Commission (European Economic Forecast Winter 2022, February 2022); International Monetary Fund (World Economic Outlook, October 2021 and January 2022; 2021 Article IV Consultation, January 2022), World Bank, Bank for International Settlements (BIS), OECD, the Social Progress Imperative (2021 Social Progress Index), IFOP (daily presidential election polls), Haver Analytics. 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/394732.

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 of Global Sovereign Ratings
Initial Rating Date: May 12, 2011
Last Rating Date: October 15, 2021

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