London, 14 December 2012
Fitch Ratings has affirmed France’s Long-term foreign and local currency Issuer Default Ratings (IDRs) as well as its senior debt at ‘AAA’. Fitch has also simultaneously affirmed France’s Country Ceiling at ‘AAA’ and the Short-term foreign currency rating at ‘F1+’. The rating Outlook on the Long-term rating is Negative.
The affirmation of France’s ‘AAA’ status is underpinned by its wealthy and diversified economy, stable political, civil and social institutions and its exceptional financing flexibility reflecting its status as a large benchmark eurozone sovereign issuer. Moderate household indebtedness and a relatively high savings rate render the French economy less exposed to private sector deleveraging than several high-grade peers, notably the U.K. (‘AAA’/Negative) and the U.S. (‘AAA’/Negative). Moreover, with net foreign debt equivalent to 23.1% of GDP (at end-2011), broadly in line with the ‘AAA’ median, and a current account deficit below 2% of GDP, relative to eurozone peers France is not especially exposed to an external financing shock.
France has a track record of relative macro-financial stability including low and stable inflation. The fiscal cost of support for the financial sector in the aftermath of the global financial crisis was minimal and the associated contingent liabilities from the provision of sovereign guarantees on debt issued by French banks currently stands at EUR24bn and are expected to be extinguished by the end of 2014. Despite on-going support for Dexia, including an additional EUR2.56bn capital contribution from the French state and state guarantees in support of Credit Immobilier de France Developpement (‘A’/Stable) and Banque PSA Finance, the risk that contingent liabilities from the banking sector will be crystallised onto the sovereign balance sheet has diminished as French banks have significantly reduced their exposure to ‘peripheral’ eurozone sovereigns and improved their capital and funding profiles.
The fiscal and rating risk from contingent liabilities arising from the eurozone crisis are material. France has already incurred commitments totalling EUR41.1bn (approx. 2% of GDP) and as the second largest guarantor of the EFSF (‘AAA’) it has a maximum commitment of EUR158.5bn. France’s paid-in capital contribution to the European Stability Mechanism (‘AAA’/Stable) is EUR16.2bn with a further EUR126.4bn in callable capital. While other highly-rated euro area sovereigns face significant fiscal risks from the eurozone crisis, the larger budget deficit and public debt burden renders the rating of France more at risk than the ratings of its eurozone ‘AAA’ peers.
A weakness in France’s sovereign credit profile relative to most other ‘AAAs’ – except for the U.K. and U.S., the ratings of which are also on Negative Outlook – is the high and rising level of public debt. Fitch estimates that general government gross debt (GGGD) will be equivalent to 90% of GDP by the end of 2012 compared to the current ‘AAA’ median of 53%. Only the U.K. and U.S. are more indebted, while the GGGD to GDP ratio for Germany, the next most indebted ‘AAA’ sovereign, is 82% and projected to decline from next year. Despite relatively high public debt, interest service costs are low and consistent with its ‘AAA’ rating at 5% and 2.6% of government revenues and GDP respectively. Moreover, high public debt is supported by a broad and stable revenue base that reflects the efficacy of the French state in levying and collecting tax.
Under the Fitch baseline scenario, government debt to GDP is expected to peak around 94% in 2014 compared to Fitch’s previous projection of 92%, higher than any other ‘AAA’-rated sovereign with the exception of the U.K. and the U.S. and significantly higher than other AAA- rated euro area peers. This is at the limit of the level of indebtedness consistent with France retaining its ‘AAA’ status assuming the government debt is firmly placed on a sustainable downward path from 2014.
Fitch judges financing risk to be very small reflecting an average debt maturity of seven years and France’s status as a core benchmark issuer of euro-denominated debt. Nonetheless, France, like other eurozone member states, does not enjoy assurance against market panics that accrue to non-EMU peers from a national central bank able and willing to intervene in its home sovereign debt market. Under Fitch’s Sovereign Rating Criteria and model, eurozone sovereigns are assessed to have a somewhat lower debt tolerance for a given rating.
The transposition of the EU Fiscal Compact into national law and the creation of the High Council of Public Finances in 2013 to provide an independent opinion on the official economic and budget forecasts should enhance the credibility of the fiscal consolidation effort. The Council will also monitor the government’s compliance with the multi-annual fiscal planning law and will be charged with identifying and making public any major budget slippage.
Relative to high-grade peers, the flexibility and dynamism of the economy (and tax base) is constrained by rigidities in the labour and product markets as well as a less favourable business environment. A secular albeit gradual decline in competitiveness, especially relative to Germany and against the backdrop of structural reforms designed to enhance competitiveness being adopted across Europe, poses a significant risk to medium-term growth and employment prospects as well as the sustainability of public finances. In recognition of the competiveness and employment challenge facing France, the government adopted the National Compact for Competitiveness and Jobs including a EUR20bn (1% of GDP) corporate tax credit. The additional budget measures in June, ratification of the Fiscal Compact and the acknowledgement by the government of the necessity of reforms to enhance competiveness and employment creation have been supportive of France’s ‘AAA’ status. Fitch also recognises that the government is committed to further reform, notably to the labour market that is currently subject to negotiations by the ‘social partners’ and which the government has stated it will implement by March 2013.
RATING OUTLOOK – NEGATIVE
In line with previous guidance, the Negative Outlook is expected to be resolved during 2013 and indicates a slightly greater than 50% chance of a downgrade. The resolution of the Negative Outlook through an affirmation of France’s AAA’ rating or a rating downgrade will be determined by an assessment of the following factors.
- The pace and ambition of economic reform. In the near-term, the prospective reform of the labour market will be a key indicator of the political and public support for substantive measures that would enhance competitiveness and the growth potential of the French economy necessary to underpin confidence in the long-run sustainability of public finances.
- An assessment of France’s medium-term growth outlook in light of the headwinds from the eurozone crisis as well as progress and prospects for economic reform.
- The likelihood that the government will meet its deficit and debt targets and implement structural fiscal measures that provide confidence that public debt will be on firm downward path from 2014.
- The fiscal and economic risks associated with the eurozone debt crisis. An intensification of the crisis would place additional pressure on France’s sovereign ratings.
KEY ASSUMPTIONS AND SENSITIVITIES
For the purposes of its fiscal projections, Fitch forecasts growth of 0.3% in 2013 and 1.1% in 2014 before the economy converges to an assumed medium-term trend rate of growth of 1.6% in 2016. This compares to the government forecast of 0.8% growth in 2013 rising to 2% from 2014. The difference in economic forecasts largely accounts for the higher general government gross debt (GGGD) to GDP ratio projected by Fitch compared to official projections. Fitch expects GGGD to GDP to peak at 94% in 2014 and gradually decline thereafter to 89% by 2017 while the government projects a peak of 91.3% in 2013 declining to 82.9% by 2017.
It is assumed by Fitch that commitments made by eurozone policymakers at recent summits, including the creation of a single supervisory mechanism for European banks will be implemented. It also assumes that the risk of fragmentation of the eurozone remains low and is not incorporated into Fitch’s current rating of France, though Fitch’s ‘CCC’ rating of Greece does reflect a material risk of Greek exit from EMU over the new few years.
The rating also incorporates Fitch’s assumption that the government will adhere to its commitments under the Stability and Growth Pact, Fiscal Compact and as set out in its Multiyear Public Financing Plan.
The rating is potentially sensitive to policy actions that would materially increase public debt and/or contingent liabilities as a result of state intervention in the domestic economy and industry.
FISCAL AND ECONOMIC OUTLOOK
France is set to meet or better its budget deficit target for the fourth consecutive year in 2012 with an expected outturn of 4.5% of GDP. The new government is committed to deficit reduction, in particular meeting the 3% of GDP headline deficit target for 2013 and implies an ambitious 2 percentage points of GDP decline in the structural budget deficit to 1.6% of GDP. It plans to close the structural deficit by 2016 and bring the headline budget close to balance by 2017. The government’s fiscal consolidation measures on the income side are front loaded while the expenditure measures will be more constant over the next five years. The government’s medium-term fiscal plan combined with the additional expenditure savings that will be required from 2014 to finance the Tax Credit for Competitiveness and Jobs implies an even split between revenue and spending measures in achieving structural budget balance by 2017. However, government projections for economic growth are more optimistic than Fitch’s and further consolidation measures will likely be needed. However, the scope for further increasing the tax burden that is already amongst the highest in the OECD is limited by the need to strengthen France’s international competitiveness.
Sustaining a 2% economic expansion from 2014 and into the medium term as projected in the government’s consolidation plans is unlikely without the successful implementation of additional reforms (on top of some of the measures already announced) to boost France’s growth potential. Failure to reform the economy further will increase the challenge of consolidating public finances in the medium term and erode sovereign creditworthiness. Analysis by the IMF, OECD and European Commission suggest that labour market and other structural reforms, including reducing the ‘tax wedge’ between pre and post-tax wage costs as well as improving the business environment, are required to materially enhance competitiveness, job creation and the growth potential of the French economy. Achieving and sustaining a balanced budget and primary (non-interest) surplus of more than 2% of GDP will be necessary to firmly place public debt on a firm downward path towards 80% of GDP by the end of the decade that would bring France more in line with ‘AAA’ peers and the requirements of the Fiscal Compact. This would represent an unprecedented budgetary performance by historical standards and will require substantive fiscal reform if space for reducing the taxes on employment is to be secured.
France’s fiscal space to absorb further adverse shocks without undermining its ‘AAA’ status is largely exhausted which underlines the urgency in tackling fiscal and structural economic challenges. The gradual decline in French competitiveness predates the 2008-2009 crisis and pressures are intensifying from outside Europe as well as within. While the competitive challenge can be over-stated in the case of France – its macroeconomic performance has been in line with major ‘AAA’ peers and the current account deficit at 2% of GDP is not excessive – without further reforms it will worsen and further undermine medium term growth prospects.
In public statements the government has shown a commitment towards economic reform. However, measures announced so far by the new administration including a EUR20bn tax credit for firms under the National Compact for Competitiveness and Jobs, are unlikely to be sufficient to reverse the secular decline in competitiveness. The government plans to announce labour market reforms early in 2013, which will provide it with another important opportunity to demonstrate that it is committed to on-going structural reform.