Morningstar DBRS Changes Trends on Republic of France to Negative, Confirms Credit Ratings at AA (high)

DBRS Ratings GmbH (Morningstar DBRS) changed the trends on the Republic of France's (France) Long-Term Foreign and Local Currency - Issuer Ratings to Negative from Stable and confirmed the ratings at AA (high). At the same time, Morningstar DBRS confirmed France's Short-Term Foreign and Local Currency - Issuer Ratings at R-1 (high). The trend on all Short-Term credit ratings remains Stable.

KEY CREDIT RATING CONSIDERATIONS
The trend change to Negative from Stable reflects Morningstar DBRS' view of higher execution risks regarding France's capacity to reduce its large fiscal deficit and high public debt ratio in the coming years, not least related to rising debt interest costs. Higher defense expenditures also could put upward pressure on the fiscal deficit over the medium term. The achievement of fiscal and debt results close to the forecasts outlined in France's Medium-Term Fiscal Structural Plan (MTFSP; October 2024), including a fiscal deficit below 3% of GDP in 2029, requires significant additional fiscal adjustments. France's 3% deficit target has been postponed to 2029 from 2027, and fiscal targets have been revised for 2024, with the deficit currently estimated at around 6%, versus 4.4% anticipated in France's Multiannual Budgetary Programming Law for 2023-27 (December 2023) and 5.1% in its April 2024 Stability Programme. France has currently one of the largest fiscal deficits in the Euro area. Due to the fragmented composition of the National Assembly, France's 2025 budget was adopted in February 2025 instead of year-end 2024. The 2025 budget, which includes spending savings but also some temporary additional tax measures, aims at a 5.4% of GDP deficit this year versus 5% targeted in the MTFSP and 4.1% in the April 2024 Stability Program. Structural fiscal consolidation measures needed in the coming years to meet the MTFSP's targets will therefore be significant. France's debt-to-GDP ratio is likely to remain higher for longer over the medium term due to a more gradual than anticipated fiscal consolidation contributing to the continued growth in interest costs. The debt ratio is expected to remain at around 116% until 2029 as per France's MTFSP from 112.7% in 2024 as per France's Budget Law for 2025. According to the International Monetary Fund, interest costs are expected to increase to 2.6% of GDP in 2027 from 1.3% in 2020, versus 2.0% in 2027 for the Euro area from 1.4% in 2020.

France's credit ratings remain underpinned by the country's wealthy and diversified economy, sound public institutions, and strong debt management. France is a core member of the euro area and financial stability risks are contained. The economy has been resilient during the past 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.

CREDIT RATING DRIVERS
The credit ratings could be downgraded if there is a failure to address fiscal imbalances over the medium-term, for example if current fiscal targets are not met or if additional fiscal adjustments fail to be made; or if the political environment materially weakens the effectiveness of the government's economic policy. The credit ratings could be upgraded if the government structurally improves its fiscal position and achieves a meaningful reduction in its debt ratio. The trend could return to Stable if fiscal and debt outcomes are better than expected and the government makes additional adjustments to provide comfort that medium-term fiscal goals can be achieved.

CREDIT RATING RATIONALE
High Government Debt and Increasing Interest Costs Mitigated by Strong Public Debt Management
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 98.1% in 2019 to 114.8% in 2020, driven by the higher debt stock and the decline in GDP due the pandemic. Despite the economic recovery, France's public debt ratio remained high, although declining to 109.9% in 2023. Due to the expected large fiscal deficit last year, the debt-to-GDP ratio is estimated to have grown again to 112.7% in 2024. France's MTFSP foresees this ratio increasing to around 116% in 2027 and then gradually declining to 113% by 2031. The country's high debt ratio remains a vulnerability for France as it exposes the country to higher interest rates when refinancing. According to the International Monetary Fund, interest costs are expected to increase to 2.6% in 2027 from 1.3% in 2020.

France continues to benefit from its very strong debt management. The central government took advantage of favourable financing conditions before the European Central Bank's monetary tightening to extend the average maturity of its negotiable debt, which stood at 8.5 years as of end-January 2025, ensuring a gradual passthrough from higher rates to higher funding costs. These features, along with France's large and diversified investor base, strong investor demand and liquidity of its debt, support Morningstar DBRS' positive qualitative adjustment for the "Debt Management and Liquidity" building block assessment. Nevertheless, Morningstar DBRS will monitor the evolution of France's relative funding cost compared with its Euro area peers.

Fiscal Consolidation Delayed and Still Subject to Some Execution Risks
Despite the unwinding of exceptional support measures, France's current fiscal deficit remains well above the 2017-2019 average fiscal deficit of 2.7% of GDP. Over the past few years fiscal consolidation has been delayed. In 2023, the fiscal deficit of 5.5% of GDP was higher than the government's latest estimate of 4.9% of GDP, mainly due to lower than anticipated tax revenues, while inflation-related support measures continued to weigh on the fiscal balance. Accounting adjustments related to the switch of the national accounts to the 2020 base also negatively impacted the 2023 deficit for around 0.15% of GDP. For 2024, a fiscal deficit of around 6% of GDP is expected compared with the 4.4% anticipated in France's Multiannual Budgetary Programming Law for 2023-27 (December 2023) and 5.1% in its April 2024 Stability Programme.

France's MTFSP foresees a fiscal deficit below 3% of GDP in 2029 but the higher political fragmentation in the National Assembly since the July 2024 snap legislative elections could hinder decisive budgetary government action in the coming years. In addition, the international geopolitical context and the trade environment could also pose some execution risks regarding France's capacity to deliver on fiscal consolidation. France's 2025 budget, which includes spending savings but also some temporary additional tax measures, aims at a 5.4% of GDP deficit this year versus 5% targeted in the MTFSP and 4.1% in the April 2024 Stability Program. Structural fiscal consolidation efforts needed in the coming years to meet the MTFSP's targets are therefore significant, starting with the 2026 budget. The MTFSP anticipates a 4.6% of GDP fiscal deficit in 2026. Morningstar DBRS understands that the government is currently taking actions to improve the monitoring and management of its public finances.

France Benefits from Very High Governance Indicators But Higher Political Fragmentation and Polarization Could Continue to Prove Challenging For Economic and Fiscal Policy Setting
France's credit ratings are supported by high institutional strength and very strong governance indicators including the rule of law. President Macron was re-elected in April 2022 after defeating Marine Le Pen of the "Rassemblement National" by a narrower margin than in 2017. While the ruling coalition lost its absolute majority in the June 2022 legislative elections, the government recommitted to its reform agenda, including the pension reform passed in March 2023. However, the July 2024 snap legislative elections reflected the growing political fragmentation and polarization of the French electorate. The government of Prime Minister Barnier fell following a vote of no confidence in the National Assembly on December 4, 2024. This was the first successful vote of no confidence in France since 1962. This led to delays in the approval of France's 2025 budget which was passed in February 2025 under the government of Prime Minister Bayrou. Morningstar DBRS considers that the fragmented composition of the National Assembly could constrain effective economic and fiscal policy setting. The next scheduled national election in France is the Presidential election in 2027. As per France's Constitution, no further dissolution of the National Assembly shall take place within a year following snap legislative elections, which in practice means before mid-2025.

Despite Various Macroeconomic and Geopolitical Headwinds, the French Economy Remains Resilient
France benefits from its large, diversified and resilient economy. The French economy and labour market have faced various challenges in recent years including a weakening in the global trade environment, 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 1.1% in 2023 (seasonally and working-day adjusted) versus 0.4% on average in the Euro area. In 2024, the French economy is expected to have grown by 1.1%, which is again more than the Euro area, thanks to foreign trade and public spending. Supported by the labour reforms implemented in recent years, the national unemployment rate remains at historically low levels standing at 7.3% in Q4 2024.

The French government expects real GDP to grow by 0.9% in 2025. Private consumption should moderately support economic growth thanks to the purchasing power gains in recent years, falling inflation and the likely drawdown of households' high savings ratio. In February 2025, inflation is expected to have fallen below 1.0% YoY for the first time since February 2021, at 0.8%. A lower inflationary environment could support consumer confidence and contribute to a reduction of households' gross saving ratio, which is estimated at around 18% in 2024 compared with 14% on average between 2014 and 2019. Nevertheless, the geopolitical and trade tensions could weigh on the French economy growth. France is less directly exposed to US tariffs than other large Euro area economies, but it could be indirectly impacted given the economic and industrial interlinkages with its European counterparts.

Financial Stability Risks Remain Contained
Morningstar DBRS considers the French banking system to be sound overall, albeit one of the least profitable banking systems in Europe. Rising interest rates until mid-2024 have pressured net interest income of French banks, in particular of those with large exposures to the French retail market. Nevertheless, the strength in corporate and investment banking, asset management and insurance boosted French banks' revenues and profitability in 2024. French banks' cost of risk increased in 2024 but remains manageable and continues to reflect strong asset quality. The ratio of nonperforming loans to total loans was 2.1% in Q3 2024 versus 2.5% in Q4 2019. French banks remain well capitalised. The aggregate Common Equity Tier 1 capital (CET1) ratio stood at 15.7% in Q3 2024 versus a pre-pandemic level of 15.3% in Q4 2019.

Non-financial corporations (NFCs) and households showed their resilience in a higher financing cost environment, despite their debt-to-GDP levels which are above the euro area average. NFCs continue to benefit from a fixed-rate oriented debt structure, robust margins and high cash levels, although reducing. The French residential real estate market faced a price and volume correction in recent years as demand contracted due to higher interest rates on new loans, but related financial stability risks were 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 0.3% of GDP from 2015 to 2019, widened to 2.1% in 2020 as the pandemic affected tourism and service sector inflows and dampened the export performance of the aeronautics and the automobile industries. After a surplus of 0.3% in 2021, the current account deficit reached 1.2% of GDP in 2022 due to the energy shock and decreased to 1% in 2023 and 0.4% in 2024 on the back of decreasing energy prices and the large surpluses of the tourism and financial services sectors in 2024. The IMF expects the current account deficit to remain close to balance by 2027. The net international investment position (NIIP) is estimated at -24.8% of GDP in 2024 by the International Monetary Fund. 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.

ENVIRONMENTAL, SOCIAL, AND 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 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 Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at: https://dbrs.morningstar.com/research/450423.

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 (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 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 these credit ratings include France's National Medium-Term Fiscal-Structural Plan (October 2024), National Institute of Statistics and Economic Studies (INSEE), Banque de France (Macroeconomic Projections, December 2024; Financial Stability Report, December 2024), Agence France Tresor, National Court of Audit (The Situation of Public Finances at the Start of 2025, February 2025), Eurostat, European Commission (European Economic Forecast Autumn 2024; Assessment of France's Medium-Term Fiscal-Structural Plan, November 2024; Assessment of the French Medium-Term Plan in light of the Additional Information Provided on 16 January 2025, February 2025), International Monetary Fund (World Economic Outlook, October 2024; World Economic Outlook Update, January 2025), World Bank, Bank for International Settlements (BIS), OECD, 2025 AlTi Global Social Progress Index, European Environment Agency and Macrobond. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were 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/450422.

These credit ratings are 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: 12 May 2011
Last Rating Date: 20 September 2024

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