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

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

KEY CREDIT RATING CONSIDERATIONS

The Stable trend reflects Morningstar DBRS’ view that risks to the credit ratings are balanced. Despite multiple headwinds related to geopolitical and global trade tensions, monetary tightening and high inflation, the French economy was resilient in 2023. Real GDP grew by 0.9% versus 0.5% on average in the Euro area. In 2024, private consumption is expected to drive economic growth, supported by continued purchasing power gains in recent years, falling inflation and the likely decline of households’ high savings ratio. The government expects real GDP growth of 1% this year. However, fiscal consolidation has been slower than anticipated. The government recently announced that the actual fiscal deficit for 2023 will be higher than its latest estimate of 4.9% of GDP. The capacity of the government to execute on its commitment to structurally reduce its large fiscal deficit and high public debt ratio will be a key credit rating factor in the coming years.

France’s AA (high) ratings remain 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 financial stability risks are contained. The economy is resilient during crises due in part to strong social protections. Nevertheless, the country has the highest level of public expenditure-to-GDP among advanced economies which has historically proved difficult to reduce, making fiscal rebalancing more challenging. Policy predictability decreased following the legislative elections in June 2022 when the governing alliance lost its absolute majority in the National Assembly. Since then, President Macron’s weaker position in parliament and political fragmentation undermine public support for the government’s structural reform agenda and its intention to repair public accounts – key for the country to maintain its very strong credit profile.

CREDIT RATING DRIVERS

Morningstar DBRS could upgrade France’s credit ratings if fiscal consolidation is faster and stronger than currently expected leading the public debt ratio to a sustained downward path over the medium term.

Morningstar DBRS could downgrade France’s credit ratings if the government takes longer than is currently expected to repair the medium-term fiscal outlook, or if the political environment materially weakens the government’s ability to address economic challenges.

CREDIT RATING RATIONALE

Despite Various Macroeconomic and Geopolitical Headwinds, the French Economy Remains Resilient

The French economy and labour market faced various challenges last year including geopolitical and global trade tensions, monetary tightening, high inflation and a relatively weak economic environment in Europe, especially in Germany, which is a key trade partner for France. Nevertheless, real GDP grew by 0.9% versus 0.5% on average in the Euro area and the national unemployment rate remained at historically low levels. That said, it increased in the two last quarters of to stand at 7.5% in Q4 2023. While many of those same headwinds are persistent this year, the French government expects real GDP growth of 1%. Private consumption should support economic growth thanks to the continued purchasing power gains in recent years, falling inflation and the likely decline of households’ high savings ratio. Inflation has declined sharply in the last twelve months and stood at 3.0% YoY in February 2024, its lowest level since January 2022. A lower inflationary environment should support consumer confidence and contribute to a reduction of households’ gross saving ratio, which was around 17% in 2023 compared with 14% on average between 2014 and 2019.

Deficits Remain High But The Government is Committed to Adjust Public Spending in the Near Term

The recurring economic shocks since 2020 and the government’s exceptional support measures to protect businesses and households have forced a significant deterioration of the fiscal balance. The fiscal deficit reached a peak of 9% of GDP in 2020 before declining to 6.5% in 2021 and to 4.8% in 2022. For 2023, the government expects the actual fiscal deficit to be higher than its latest estimate of 4.9% of GDP, due to lower than anticipated tax revenues, while inflation-related support measures continued to weigh on the fiscal balance. This is well above the 2017-2019 average fiscal deficit of 2.8% of GDP. Due to the 2023 deficit slippage and the downward revision of real GDP growth to 1% for this year compared to the 1.4% assumption in the state budget law, the government has reacted swiftly in February 2024 in reducing by EUR 10 billion the level of spending planned for this year. This spending adjustment follows the quasi-complete unwinding of inflation-related exceptional budgetary measures in the 2024 budget law. Morningstar DBRS understands this is only an additional consolidation step as the government is willing to strengthen the budgetary impact of its spending reviews, potentially in a revised budget law during the summer. At the same time, the government is preparing for higher spending adjustments in the 2025 budget law. The government expects the deficit to fall below 3.0% of GDP in 2027.

France’s public sector accounts remain stressed by high structural public spending. The general government expenditure-to-GDP ratio stood at 58.3% in 2022, the highest in the EU which has an average of 49.6%. Social protection and public health expenditure accounted for 32.9% of GDP in 2022 versus 27.2% on average in the EU. Despite the cost-saving benefits from the pension reform, a potentially unsuccessful upcoming spending adjustment, a weaker than expected economic performance, or both, would reduce the pace of fiscal consolidation and challenge the government’s deficit target of below 3% for 2027.

High Government Debt Mitigated by 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, albeit then declining to 111.8% in 2022. The multiannual programming law for 2023-27 adopted in December 2023 foresees a stabilization of the ratio around 110% in 2023-2025 and then gradually declining to 108% by 2027. The country’s high debt ratio remains a vulnerability for France as it exposes the country to increases in interest rates. Interest costs are expected to increase from 1.2% of GDP in 2020 to 2.2% by 2026, according to the IMF. However, France continues to benefit from its strong debt management. The central government took advantage of favourable financing conditions in recent years to extend the average maturity of its negotiable debt to close to 8.5 years as of end-February 2024, ensuring a gradual passthrough from higher rates to higher funding costs. These features support Morningstar DBRS’ positive qualitative adjustment for the “Debt Management and Liquidity” building block assessment.

Financial Stability Risks Contained Despite Monetary Tightening

In a context of higher although reducing inflation, still high interest rates for borrowers and pull back of government support, pressure has started to build up on bank balance sheets from corporate insolvencies. Nevertheless, French banks confront those headwinds well capitalised, and with strong asset quality metrics and liquidity positions. The aggregate Common Equity Tier 1 capital (CET1) ratio stood at 15.8% in Q3 2023 versus a pre-pandemic level of 15.3% in Q4 2019, and the ratio of nonperforming loans to total loans was 1.9% in Q3 2023 versus 2.5% in Q4 2019. Morningstar DBRS considers that potential vulnerabilities could stem from particular sectors, such as construction, consumer lending and commercial real estate (CRE).

Non-financial corporations (NFCs) and households also appear resilient in the current financial environment, despite showing higher debt-to-GDP levels than the Euro area average. NFCs benefit from a fixed-rate oriented debt structure, robust margins and high cash levels. Although the French residential real estate market faces an ongoing correction, related financial stability risks are contained thanks to the low unemployment rate, high household savings rate and the French mortgage funding model, typically made of fixed-rated and long maturity loans.

External Sector Risks Are Relatively Limited

France does not have material external imbalances. 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. The current account deficit reached 2.0% of GDP in 2022 due to the energy shock and decreased to 1.2% in 2023 on the back of decreasing energy prices, but the trade deficit in 2023 remained much higher than in the pre-pandemic years. The IMF expects the current account deficit to gradually narrow towards balance by 2028. The net international investment position (NIIP) stood at -26.6% of GDP in 2023. France’s open economy with extensive trade, investment, and financial linkages throughout Europe and globally support the positive qualitative adjustment for the “Balance of Payments” (BOP) building block assessment. External liabilities are primarily denominated in local currency. Moreover, despite a negative NIIP, the BOP investment income is largely positive thanks to the foreign direct investment (FDI) portfolio return.

The Government Passed Important Reforms Despite a Challenging Political And Social Environment

France’s credit ratings are supported by high institutional strength and very strong governance indicators including the rule of law, despite growing political polarisation. President Macron of the “Renaissance” party was re-elected in April 2022 after defeating Marine Le Pen of the “Rassemblement National” by a narrower margin than in 2017. The strong performance of the far-left and the 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 social tensions, the government passed its pension reform in March 2023. Morningstar DBRS is of the view that the main pillars of the reform, including raising the retirement age to 64 and extending the minimum full-rate pension contribution years to 43, should improve employment outcomes by further encouraging labour participation. In January 2024, a government reshuffle was decided. Morningstar DBRS takes the view that it reflected the willingness of President Macron to find a new political impetus following the strong social and political challenges seen during the pension reform and ahead of the European Parliament election to be held in June 2024. The elections could have implications on the government’s capacity to pursue the reform agenda and spending adjustments.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

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

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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: https://dbrs.morningstar.com/research/430017/.

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 (October 6, 2023) https://dbrs.morningstar.com/research/421590/global-methodology-for-rating-sovereign-governments. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for this credit rating include France’s Multiannual Programming Law for 2023-27, National Institute of Statistics and Economic Studies (INSEE), Banque de France (Macroeconomic Projections, December 2023; Assessments of Risks to The French Financial System, December 2023), Agence France Tresor, Eurostat, European Commission (European Economic Forecast Winter 2024); International Monetary Fund (World Economic Outlook, October 2023), World Bank, Bank for International Settlements (BIS), OECD, the Social Progress Imperative (2024 Social Progress Index), Haver Analytics. Morningstar DBRS considers the information available to it for the purposes of providing this credit 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

Morningstar DBRS does not audit the information it receives in connection with the credit 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. Morningstar DBRS’ outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/430015/.

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

Lead Analyst: Mehdi Fadli, Senior Vice President, Sector Lead, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: May 12, 2011
Last Rating Date: September 2022, 2023

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