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 social and economic challenges that stretch France’s public balance sheet, the government remains committed to gradually improving its medium-term fiscal performance. France’s strong 2021 recovery was interrupted in 2022 by the energy price shock and the rapid rise in interest rates. The ensuing stress to the global banking system and the repricing in global financial markets add to France’s uncertain economic environment. Current global financial market tension occurs at a challenging time, as French authorities make controversial changes to the pension system. The series of economic shocks, a population on edge over the reform effort, and the many rounds of public support measures all complicate medium-term repair to public finances in France. Despite the mounting challenges, the government recently reaffirmed its pledge to reduce, albeit at a slower pace than European peers, its large fiscal deficit.

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 in part to strong social protections. However, this benefit results in structurally high public expenditures that are difficult to reduce and delay the rebalancing of fiscal accounts. Policy predictability decreased following the legislative 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 fragmentation undermine public support for the government’s ambitious reform agenda. Passage of pension reform via Article 49.3 of the French Constitution aggravates an already polarised electorate and could challenge the government’s effort to slow the pace of expenditure growth and repair public accounts – 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; or if the deterioration in the political environment materially weakens the government’s ability to address economic challenges.

RATING RATIONALE
The Government Passed Pension Reform And Survived Censure Votes

President Macron of the “En Marche” party was re-elected in April 2022. He defeated Marine le Pen of the “National Rally” by a narrower margin than in 2017. The strong performance of the far-left and far-right coalitions illustrates the growing polarisation in France. While the ruling coalition lost its absolute majority in the June 2022 legislative elections, the government recommitted to the reform agenda previously interrupted by a series of events, including the “gilets jaunes” protests, the pandemic, and the energy crisis.

After months of consultation and rolling protests, the government passed pension reform in March 2023 using a constitutional procedure to bypass a vote in the legislature. In the following days as social unrest intensified, the government survived two votes of no confidence – cementing pension reform into law. DBRS Morningstar is of the view that the main pillars of the reform, including raising the retirement age from 62 to 64 and extending the minimum contribution years to 43, should improve employment outcomes. The government expects 200,000 additional jobs will be created by 2027. However, the reform is unwelcome by an important share of the French population and the manner by which it was enacted has further inflamed social tensions. The disgruntled public and the fragmented parliament constrain what is left of the government’s still-ambitious reform agenda. Despite the political complications, France is a strong performer on governance indicators and this government remains notionally committed to repairing medium-term fiscal accounts.

The 2022 Price And Interest Rate Shocks Interrupted France’s Strong Post Pandemic Recovery And Will Slow Growth In 2023

The French economy rebounded by 6.8% in 2021 from the 7.9% pandemic-related contraction in 2020. Russia’s invasion of Ukraine last year and the subsequent energy price and interest rate shocks slowed 2022 output. The harmonised consumer price index in France increased at an average annual rate of 5.9% in 2022. The inflation rate in France has been more contained compared to the 8.4% euro area average thanks to robust energy price protections implemented by the government. Comparatively lower rates of inflation, as well as resilient levels of investment, strong labour markets, and a recovery in tourism resulted in 2.6% GDP growth in 2022.

Economic performance will inevitably slow this year, as private sector activity is hampered by persistent inflationary pressures and higher interest rates. Passthrough from higher food and services prices will likely keep components of inflation stubbornly high this year. While the medium-term effects of pension reform on the economy should be positive – the government expects GDP to be 1.1% higher by 2030 as a result of the reform – the near-term consequences of public protests could be adverse. The impact from previous episodes of social disruption on GDP were marginal, though much will depend on the severity and duration of social unrest and industrial action in response to the reform. In its March 2023 projections, the Banque de France (BdF) projects 0.6% growth in 2023. Downside risk to this outlook stems from considerable uncertainty around events in the global banking system, the stickiness of higher core inflation, the evolution of interest rates, and the duration of government measures.

The French Banking Sector Has Been Tested By Global Stress; Challenges Appear Manageable

The French banking sector has performed strongly in recent years, pandemic and energy crises notwithstanding. Pressure has started 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. Likewise, French bank shares were not entirely immune to the stress from global financial markets that ensued following regional bank failures in the USA. But French banks confront the many challenges well capitalised, and with strong liquidity positions and asset quality. The ratio of Tier 1 capital to risk-weighted assets was 14.9% in 2022, and the ratio of nonperforming loans to total loans was 2.4%. Corporates also appear resilient despite the difficult environment. The BdF expects EUR 6.4 billion in gross losses from the EUR 143.3 billion in state guaranteed loans (PGE) that began in 2022. 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.

Large 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 appears on track to commit EUR 20 billion of France 2030 plan by the end of 2023.

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 from October 2021 through end-2023 are expected to amount to over EUR 60 billion or roughly 2.2% of GDP. This is in part why the deficit remained high at 5.0% in 2022, despite strong revenue growth and unwinding pandemic-related spending. Additional spending demands, a weaker than expected economic performance, or both, would challenge the government’s 5.0% of GDP deficit target for 2023. Even including cost-saving benefits from pension reform, the government does not expect the deficit to fall below the 3.0% of GDP threshold until 2027, among the slowest consolidations in Europe.

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 115.0% in 2020, and then declined to 111.6% in 2022 according to the latest government figures, 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 interest rates increase the cost of servicing debt when using Maastricht 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 8.5 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.

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 1.8% 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 surplus of 0.4% in 2021. After returning to deficit in 2022 due to the increase in energy prices, the IMF expects a 1.5% deficit this year and for the current account to narrow gradually towards 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, the net international investment position (NIIP) improved to -23.5% of GDP in 2022, and 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.

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: 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 (17 May 2022).

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/411590.

EURO AREA RISK CATEGORY: LOW

Notes:
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/401817/global-methodology-for-rating-sovereign-governments (29 August 2022). In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (17 May 2022) in its consideration of ESG factors.

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, December 2022), Agence France Tresor, High Council on Public Finances, Eurostat, European Commission (European Economic Forecast Winter 2022); International Monetary Fund (World Economic Outlook, October 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/411589.

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: September 30, 2022

DBRS Ratings GmbH, Sucursal en España
Paseo de la Castellana 81
Plantas 26 & 27
28046 Madrid, Spain
Tel. +34 (91) 903 6500

DBRS Ratings GmbH
Neue Mainzer Straße 75
60311 Frankfurt am Main Deutschland
Tel. +49 (69) 8088 3500
Geschäftsführer: Detlef Scholz
Amtsgericht Frankfurt am Main, HRB 110259

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.