Fitch Ratings, London 12 July 2013
Fitch Ratings has downgraded France’s Long-term foreign and local currency Issuer Default Ratings (IDR) to ‘AA+’ from ‘AAA’. The Outlook is Stable. At the same time, the agency has affirmed France’s Short-term foreign currency IDR at ‘F1+’ and the Country Ceiling at ‘AAA’.
KEY RATING DRIVERS
The downgrade of France’s foreign and local currency IDRs reflects the following key rating drivers and their relative weights:
– Fitch now forecasts general government gross debt (GGGD) to peak higher at 96% of GDP in 2014 and decline only gradually over the long term, remaining at 92% in 2017. This compares with Fitch’s previous projections in December 2012 of GGGD peaking at 94% (and 92% when it first revised the Outlook to Negative in December 2011), and declining more rapidly to below 90% by 2017.
– The agency commented at the time of its previous rating review that this was the limit of the level of indebtedness consistent with France retaining its ‘AAA’ status assuming debt was firmly placed on a downward path from 2014. Its projections for France’s GGGD ratio are significantly higher than the ‘AAA’ median of 49% and ‘AA’ median of 27%. The only ‘AAA’ country with a higher debt ratio is the US (AAA/Negative), which has exceptional financing flexibility and debt tolerance afforded by the preeminent global reserve currency status of the US dollar.
– Risks to the agency’s fiscal projections lie mainly to the downside, owing to the uncertain growth outlook and the ongoing eurozone crisis, even assuming no wavering in commitment to fiscal consolidation. A debt ratio that is higher for longer reduces the fiscal space to absorb further adverse shocks.
– Economic output and forecasts are substantially weaker than when Fitch revised the Outlook to Negative. The unemployment rate has also jumped to a 15 year high of 10.9% in May 2013. The weaker economic outlook is the primary factor behind increases in the budget deficit and France remaining in the EU’s Excessive Deficit Procedure for a year longer. Fitch expects the French economy to recover less quickly then official projections, owing to headwinds from subdued external demand, weaker competitiveness, high unemployment and fiscal consolidation. Its latest forecasts are for GDP to contract in 2013 before growing by 0.7% in 2014.
– As well documented by organisations such as the OECD, IMF and European Commission, the French economy faces a number of structural challenges, including gradually declining competitiveness, weak profitability and rigidities in the labour, goods and services markets, which weigh on the medium term outlook. Fitch’s projection for long term potential growth is broadly unchanged at around 1.5%.
– France’s current account was in a deficit of 2.3% of GDP in 2012. Although that is not especially high, it has deteriorated steadily from surpluses a decade ago, reflecting a steady loss of competitiveness and export market share. This evolution has been mirrored by the rise in net external debt which has risen to 25% of GDP, compared with the ‘AAA’ median of 20%.
Despite the loss of its ‘AAA’ status, France’s extremely strong credit profile is reflected in its ‘AA+’ rating with a Stable Outlook, which reflects the following main factors.
– France’s wealthy and diversified economy and political stability entrenched by strong and effective civil and social institutions.
– Fitch judges financing risk to be very low reflecting an average debt maturity of seven years, low borrowing costs and strong financing flexibility underpinned by its status as a large benchmark eurozone sovereign issuer.
– France has a track record of relative macro-financial stability including low and stable inflation. It also benefits from moderate levels of household indebtedness and a high household saving rate.
– Since coming into office last year the Socialist government has set out and started to implement a wide-ranging programme of structural reforms, including the “National Compact for Growth, Competitiveness and Jobs” and recent labour market reforms. This may help improve the long term growth and current account position. However, the quantitative impact of the new measures is uncertain and reforms are subject to implementation risk.
– The recent structural reform of the budget procedure through the organic law that transposes the EU Fiscal Compact into national law will strengthen the confidence in the outlook for French fiscal policy. As part of the reforms an independent body, the High Council of Public Finances was created with the role to give an opinion on the growth forecasts underpinning budget forecasts. It will also monitor the government’s compliance with the multi-annual planning law and will be charged with identifying and making public any major budget slippage.
– Risks in the French banking system have eased as asset quality, funding and capitalisation have improved, though exposures to Italy remain significant.
– The intensity of the eurozone crisis has eased over the past 12 months reflecting progress with country fiscal and reform plans and policy enhancements at the EU level, including the ECB’s OMT and gradual steps towards banking union. Nevertheless, in Fitch’s view the eurozone crisis is not over and contingent liabilities arising from the crisis remain material. France has already incurred commitments totalling EUR48.1bn (2.4% of GDP) as the second largest guarantor of the EFSF. France’s paid-in capital contribution to the European Stability Mechanism (ESM) is EUR16.2bn with a further EUR126.4bn in callable capital.
The Stable Outlook indicates that a change in France’s sovereign ratings is not currently expected within the next two years, reflecting the higher tolerance of downside risks at the ‘AA+’ level.
The main factors that could lead to a negative rating action, individually or collectively, are:
– Public finances weakening materially compared to Fitch baseline projections.
– Deterioration in competitiveness and growth prospects.
– A re-intensification of the eurozone crisis or crystallisation of material amounts of contingent liabilities on French balance sheets.
The main factors that could lead to a positive rating action, individually or collectively, are:
– The government budget deficit and debt ratio declining at a significantly faster pace than currently projected to safer levels
– A significantly stronger economic recovery of the French economy than currently forecast and increased confidence in medium-term growth prospects, for example owing to sustained implementation of deep and comprehensive structural reforms.
There is uncertainty over the near- and medium-term evolution of output, unemployment and the government deficit. For the purposes of its fiscal projections Fitch forecasts the French economy to contract by 0.3% in 2013 and grow by 0.7% in 2014 and 1.2% in 2015 and converge to its long run trend of around 1.5% by 2016. This compares with the government’s forecast of growth of 0.1% in 2013, 1.2% in 2014 and 2.0% in 2015 and 2016. The difference in the economic forecasts and the headline fiscal balance largely explain the agency’s higher public debt to GDP projections compared to official estimates.
Fitch expects the headline fiscal deficit to remain above 3% of GDP into 2014 but ease to around 1% of GDP in 2017, the end of the current presidency. The government projects the shortfall to reach 2.9% and ease to 0.7%, respectively.
Fitch assumes there are no further contributions by France to the eurozone crisis mechanisms – the EFSF and ESM – than already announced. The cumulative impact of the eurozone financial assistance programmes will climb to EUR69bn in 2014 (3.4% of GDP) mostly on further EFSF disbursement to Greece and capital contribution to the ESM.
Fitch assumes that the French sovereign will continue to access market funding at low interest rates. Under Fitch’s Sovereign Rating Criteria and model, eurozone sovereigns are assessed to have a somewhat lower debt tolerance for a given rating than non-EMU peers with their own reserve currencies and national central banks willing and able to intervene in sovereign debt markets.
Fitch also does not expect further government debt raising interventions to support the banking industry. Data from Eurostat shows that by the end of 2012 EUR2.2bn of government liabilities was related to supporting the banking system. Contingent liabilities relating to guarantees to the banking sector were EUR50.6bn (2.5% of GDP).
Fitch assumes there will be progress in deepening fiscal and financial integration at the eurozone level in line with commitments by policy makers. It also assumes that the risk of fragmentation of the eurozone remains low.