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 Stable trend reflects DBRS Morningstar’s view that despite the compounding economic challenges that stretch France’s public balance sheet, the government remains committed to gradually improving its medium-term fiscal performance. The strong recovery from the COVID-19 shock has been interrupted by the energy crisis. Economic growth forecasts for the coming years have been revised down since Russia’s invasion of Ukraine and the corresponding spike in prices. Above target inflation for the foreseeable future weighs on private sector confidence and purchasing power. The government’s many rounds of support measures to help smooth the effects of inflation delay fiscal consolidation.

France’s AA (high) ratings are underpinned by the country’s wealthy and diversified economy, sound public institutions, and strong public funding profile. France is a core member of the euro area and has a sound banking sector. The economy is resilient during crises due to strong social protections. However, this benefit results in structurally high public expenditures that are difficult to reduce and complicate the rebalancing of fiscal accounts. Policy predictability has decreased following the elections in June 2022 when the governing alliance lost its majority in the National Assembly. President Macron’s weaker position in parliament and growing political polarization challenge the government’s capacity to deliver on its agenda. France’s ability to repair public accounts and stabilise then reduce the debt-to-GDP ratio are key for the country to maintain its very strong credit profile.

RATING DRIVERS
The ratings could be upgraded if fiscal consolidation 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.

RATING RATIONALE

The Energy Price Shock Interrupts France’s Strong Post Pandemic Recovery

The French economy rebounded by 6.8% in 2021 from the 7.9% pandemic-related contraction in 2020, and notwithstanding the energy price shock, GDP growth is expected to overperform trend growth in 2022. Resilient domestic demand, historically strong labour markets, a tourism-led recovery in the service sector, and comparatively lower rates of inflation will result in 2.6% growth this year, according to the Banque de France’s (BdF) recent projections. The harmonised consumer price index in France increased at an average annual rate of 5.5% in August 2022, compared to the 6.6% average in the euro area. This is in large part due to robust energy price protections implemented by the government. The additional shocks to energy prices over the summer months and the passthrough of higher input prices to food and core inflation interrupt the forward momentum. Lead survey data show that business and consumer sentiment have already deteriorated, weighing on economic activity to end the year and into 2023. Due to considerable uncertainty around the price and availability of energy supplies, the stickiness of higher inflation, and the duration of government measures, the BdF offers a forecast growth range for 2023 between 0.8% and -0.5%.

Vast Fiscal Support To Protect The Economy Weighs Heavily On Public Accounts

The government’s exceptional support measures to protect businesses and households from the re-occurring shocks since 2020 have forced a significant deterioration in the fiscal balance. The deficit reached 8.9% of GDP in 2020 and improved to 6.5% in 2021 as the economy began to recover. Spending has been directed to support health outcomes, mitigate the economic fallout from the pandemic, and finance the recovery. France Relance (EUR 100 billion or roughly 4% of GDP) and France 2030 (EUR 30 billion) are medium-term plans meant to encourage the digital and ecological transitions, and bolster the competitiveness of corporates and the labour force. The government has also mobilized large sums of money to lessen the bite to consumers and producers from high energy prices. In particular, the government’s shield against rising gas and electricity prices has been extended into 2023. All measures to offset rising prices announced since October 2021 amount to over EUR 50 billion or roughly 2.0% of GDP. Additional spending demands, a weaker than expected economic performance, or both, would challenge the government’s 5.0% of GDP deficit targets for 2022 and 2023, and further delay its commitment to rebalance accounts. Current targets do not see the deficit decline below the 3.0% of GDP threshold until 2027, among the slowest consolidations expected in the euro area.

Government Debt Expected To Stabilize At High Levels; Strong Public Debt Profile

The various shocks in recent years have resulted in a large increase in France’s public debt burden. The debt-to-GDP ratio increased from 97.4% in 2019 to 114.6% in 2020, declines to 111.5% in 2022 according to the 2023 Budget, and stabilizes roughly at this level over the forecast period. The country’s high debt metrics remain a vulnerability for France as it exposes the country to increases in interest rates. Despite the rise in inflation and the corresponding increase in rates, France continues to have a strong funding profile. The government’s average financing rate on the issuances in 2020 and 2021 were negative. Higher debt and rates increases the cost of servicing debt when using Maastrichtian accounting from EUR 31.4 billion (1.3% of GDP) in 2021 to EUR 42.2 billion (1.6% of GDP) in 2022. The government took advantage of favourable financing conditions in recent years to extend average maturities to over 8 years, ensuring a gradual passthrough from higher rates to higher funding costs. 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; Challenges Appear Manageable

The French banking sector has performed strongly in recent years, pandemic and energy crises notwithstanding. Pressure is likely to build up on bank balance sheets as insolvencies stem from the inflationary shock, the slowdown in economic activity, and the pull back of government support. But French banks confront the challenges well capitalised, and with strong liquidity positions and asset quality. According to the IMF, the ratio of Tier 1 capital to risk-weighted assets was 16.4% in the first quarter of 2022, and the ratio of nonperforming loans to total loans was 2.4%. Corporates also appear to be in good shape despite the difficult environment. This is reflected by the repayments of state guaranteed loans that began in 2022. Potential losses from these loans, according to the BdF, are low. Furthermore, the increase in corporate debt since 2020 has largely been offset by cash reserves, indicating only a slight increase in net debt since the beginning of the pandemic. The build-up of household savings since the beginning of 2020 has also been significant. These factors support our positive adjustment to the “Monetary Policy and Financial Stability” building block assessment.

Compounding Shocks Have Weakened External Accounts; Direct Links To Russia Are Limited

France’s current account deficit, which averaged 0.5% of GDP from 2015 to 2019, widened to 1.9% in 2020 as the pandemic affected tourism and service sector inflows, and dampened the export performance of the aeronautics and automobile industries. Some reversal of these forces and recovery of travel and business services led to a narrowing of the balance to 0.9% in 2021. After widening again this year due to the increase in energy prices, IMF expects the current account deficit to narrow gradually and reach balance by 2027. France’s exposure to Russia as a trade partner is limited, given that Russia represented about 1.0% of French exports and imports in 2020. Despite crisis-related deterioration in the net international investment position (NIIP) to -32.3% of GDP in 2021, France does not have material external imbalances. Its open economy with extensive trade, investment, and financial linkages throughout Europe and globally support the positive qualitative adjustment for the “Balance of Payments” building block.

Macron’s Second Term Is Challenged By The Loss Of Absolute Legislative Majority

President Emmanuel Macron of the “En Marche” party was re-elected for a second five-year term in April 2022. He defeated Marine le Pen of the “National Rally” in the second round by 58.5% to 41.5%, a margin narrower than in 2017. In his second term, Macron recommits to the reform agenda interrupted by a series of events, including the “gilets jaunes” social unrest, the pandemic, and the energy crisis. Complicating matters for Macron was his coalition’s loss of its absolute majority in the June 2022 legislative elections. The strong performance of the far-left and far-right coalitions illustrates the growing polarization in France. The fragmented parliament may constrain the government’s reform ambition and delay France’s ability to rebalance its public finances. Despite the political complications, France is a strong performer on governance indicators and this government remains committed to repairing medium-term fiscal accounts.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

There were no Environmental, Social, or Governance factors that had a significant or relevant effect on the credit analysis

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria (17 May 2022): Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at: https://www.dbrsmorningstar.com/research/403327.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in 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 (29 August 2022) https://www.dbrsmorningstar.com/research/401817/global-methodology-for-rating-sovereign-governments. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (17 May 2022) https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

The sources of information used for this rating include Ministry of Economy and Finance (Budget 2023, Stability Programme 2022), National Institute of Statistics and Economic Studies (INSEE), Banque de France (Macroeconomic Projections, September 2022), Agence France Tresor, High Council on Public Finances, Eurostat, European Commission (European Economic Forecast Summer 2022); International Monetary Fund (World Economic Outlook, April 2022; 2021 Article IV Consultation, January 2022), World Bank, Bank for International Settlements (BIS), OECD, the Social Progress Imperative (2021 Social Progress Index), 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: YES
With Access to Management: YES

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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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: https://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/403325.

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

Lead Analyst: Jason Graffam, 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: April 1, 2022

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