Frankfurt am Main, January 24, 2014
Moody’s Investors Service has today affirmed France’s Aa1 government bond rating. The outlook remains negative.
Moody’s decision to maintain the negative outlook was driven by the following key interrelated factors: (1) the continued reduction in the competitiveness of the French economy, which risks lowering its long-term growth prospects, as well as (2) the risk of a further deterioration in France’s government financial strength. This is reflected in the significant increase in the general government debt-to-GDP ratio to 93.6% in 2013 from 90.2% in 2012, and Moody’s expects a further increase to above 95% by the end of 2014.
Although the French government has introduced or announced a number of measures intended to address these competitiveness and growth issues, the implementation and efficacy of these policy initiatives are complicated by the persistence of long-standing rigidities in labour, goods and services markets as well as the social and political tensions the government is facing. Moreover, in Moody’s view, France’s fiscal policy flexibility is limited, which, together with the policy challenges noted above, imply a continued risk of missing fiscal targets.
At the same time, Moody’s has affirmed France’s Aa1 government bond rating. Credit positive rating factors that support the affirmation include: (1) France’s large and diversified economy which underpins the country’s economic resiliency; and (2) the currently modest interest burden relative to total government revenues associated with the government’s debt (i.e. its very high debt affordability) as a consequence of its strong investor base, a large tax revenue base, and low funding costs. Moreover, the risks to the French government’s finances associated with the euro area debt crisis have — at least for now — abated and French banks’ direct exposures to peripheral Europe have diminished.
In a related rating action, Moody’s has also affirmed the Aa1 ratings of Société de Financement de l’Economie Française (SFEF) and Société de Prise de Participation de l’État (SPPE), and maintained the negative outlook on their ratings. Furthermore, Moody’s has affirmed the Prime-1 rating of SPPE’s euro-denominated commercial paper programme. The senior debt instruments issued by the two entities are backed by unconditional and irrevocable guarantees from the French government.
RATIONALE FOR NEGATIVE OUTLOOK
–FIRST FACTOR – CONTINUED LOSS IN COMPETITIVENESS
The first driver underpinning Moody’s decision to maintain the negative outlook relates to a continued reduction in France’s competitiveness, as reflected in indicators like nominal unit labour costs, tax burden and, ultimately, export market shares. Nominal wages in France have outpaced productivity for more than five years now, and the desire of French exporters to maintain price competitiveness has led to falling operating margins. As a result, firms are less inclined to invest, particularly in an unfavourable economic environment. Over time, these trends may reduce the country’s long-term secular growth rate.
Moreover, the French private sector’s overall tax burden is expected to have further increased in 2013 to 47.7% of GDP, according to data from the European Commission. This represents one of the highest taxation levels among advanced economies, exceeded only by Denmark (Aaa stable) which has — relative to GDP — less than half of France’s debt stock. In addition, labour income is taxed by more than 50%, the second highest level in the OECD where the average taxation of the 34 OECD member countries was at around 36% in 2012. France’s high taxation level lowers firms’ incentive to hire, adding to pressures in the labour market and bearing down on domestic demand and economic growth.
Apart from price competitiveness issues, the lagging non-price competitiveness of French exports illustrates further structural problems, including difficulties in increasing the R&D intensity of production and products. The R&D intensity of France’s business sector (1.5% of GDP in 2012) is lower than that of other EU countries, although higher than the euro area average. Finland (Aaa stable) leads the table with a R&D intensity of 2.4% of GDP, compared with around 1.9% for Germany (Aaa negative), Austria (Aaa negative) and Denmark (according to Eurostat data).
These competitiveness issues have led to a gradual erosion of France’s export-oriented industrial base and constrain the economy’s shock-absorption capacity and, ultimately, its long-term growth potential. As a result of France’s weakened competitive position, the country’s share of world exports fell by approximately 30% between 2005 and 2012 (IMF data). France’s export market share may deteriorate further following the implementation of structural reforms designed to improve competitiveness among a number of euro area peripheral countries.
–SECOND FACTOR — RISK OF A FURTHER DETERIORATION OF FINANCIAL STRENGTH
The second factor backing the negative outlook is the risk of a further deterioration in France’s government financial strength. For 2013, the government expects to record a general government deficit of 4.1% of GDP, implying that France will miss by a wide margin its April 2012 Stability Programme target of 3%. This will extend France’s track record of non-compliance with fiscal targets.
Despite repeated commitments to fiscal consolidation, France’s high budget deficits and its low economic growth have led to a significant increase in general government debt. In 2013, the debt-to-GDP ratio rose to 93.6% (from 90.2% in 2012), and Moody’s expects a further increase to above 95% by the end of 2014. Even assuming the government is successful in implementing fiscal consolidation measures, the debt-to-GDP ratio is unlikely to start to fall until 2016. Moreover, in Moody’s view, France’s fiscal flexibility is limited as the government’s efforts to reduce the tax burden coincide with subdued medium-term growth prospects and significant political resistance to cut expenditures. As a result, Moody’s sees a continued risk of France missing its fiscal targets.
–GOVERNMENT EFFORTS TO ADDRESS PROBLEMS FACE CHALLENGES
Moody’s recognises that the government has introduced a number of measures — including a competitiveness compact, a labour market reform, and a pension system reform — aimed at addressing the competitiveness issues and at reversing the deterioration of public finances, and has stated its intention of undertaking more far-reaching reforms to promote longer-term growth while preserving the government’s fiscal position. This commitment was evidenced by the President’s announcement of a “responsibility pact,” which includes the intention to lower employers’ social contributions. The government hopes to encourage employers to hire at least a million more workers, with the revenue loss more than offset by savings in public expenditure, still to be specified by a Strategic Council reporting to the President.
However, at this juncture, a significant amount of details is lacking on how the associated increase in employment and reduction in public expenditure will be achieved. Therefore, it is difficult to assess at this time the likelihood that the plan will achieve its stated goals. The government’s mixed record on fiscal consolidation and structural reforms to date illustrates that its effectiveness in achieving far-reaching reforms may be affected by social and political constraints. These require the government to seek a broad consensus amongst social partners, with the risk that reform efforts are slowed down and diluted. These factors add to the concern that the formulation of a comprehensive multi-year strategy remains difficult.
RATIONALE FOR AFFIRMATION OF Aa1 RATING
–FIRST FACTOR — RESILIENCE OF THE FRENCH ECONOMY
The affirmation of the Aa1 government bond rating was driven by France’s economic resiliency, which is reflected in the country’s large and diversified economy, significant wealth in terms of GDP per capita, relatively high private-sector savings, and an only moderate build-up of household and corporate leverage. France’s approximately USD2.6 trillion (EUR2.0 trillion) economy is the fifth-largest globally and its per-capita income of USD35,295 (on a purchasing power parity (PPP) basis, 2012) is amongst the highest in Moody’s rated universe. The French economy is well diversified, with an important service sector and a relatively large, although declining industrial base.
–SECOND FACTOR — FRANCE’S VERY HIGH DEBT AFFORDABILITY
The second factor underpinning the affirmation of the Aa1 government bond rating relates to the French government’s very high debt affordability as a consequence of its strong investor base, a large tax revenue base, and low funding costs. France’s government bonds act as benchmarks in the European fixed-income market and have allowed the government to borrow in recent years at yields that have led to substantial declines in the government’s medium- and long-term funding costs to less than 2%. The favourable funding conditions feed into the country’s very high debt affordability as measured by interest payments, which remained below 5% of government revenues in 2013.
–CONCERNS RELATED TO FRANCE’S EXPOSURE TO PERIPHERY COUNTRIES HAVE DIMINISHED
Moreover, Moody’s concerns related to France’s exposure to European periphery countries have diminished as the intensity of the euro area debt crisis has abated more broadly, and the French banking system’s exposure to the euro area periphery has declined. The abatement of the crisis has also reduced the likelihood that contingent liabilities related to loans by the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM) will be crystallised onto the French government’s balance sheet.
WHAT COULD MOVE THE RATING UP/DOWN
Moody’s would consider moving the outlook to stable and eventually upgrading France’s government debt rating should the rating agency conclude that the planned economic reforms and fiscal measures are both implemented and effective in ways that strengthen both growth prospects and the government’s balance sheet, bolstering long-term growth and leading to a sustained reversal of the upward trajectory in its debt-to-GDP ratio.
Moody’s would likely downgrade France’s government debt rating if Moody’s confidence in the likelihood of implementation of the proposed reforms or their effectiveness were to decline, or if Moody’s views on the country’s medium- to long-term growth prospects were to deteriorate further, or if the rating agency’s expectation with respect to the medium term path of the general government’s debt-to-GDP ratio were to drift towards 100%.
France’s foreign- and local-currency bond and deposit ceilings remain unchanged at Aaa. The short-term foreign-currency bond and deposit ceilings remain Prime-1.
GDP per capita (PPP basis, US$): 35,295 (2012 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 0% (2012 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 1.3% (2012 Actual)
Gen. Gov. Financial Balance/GDP: -4.8% (2012 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -2.2% (2012 Actual) (also known as External Balance)
External debt/GDP: [not available]
Level of economic development: Very High level of economic resilience
Default history: No default events (on bonds or loans) have been recorded since 1983