London, 19 September 2014 — Moody’s Investors Service has today announced its decision to maintain the negative outlook on France’s government bond rating, which it has affirmed at Aa1.
The agency’s decision to affirm France’s Aa1 rating reflects Moody’s view that, despite negative credit pressures, the country retains significant credit strengths, including the size and wealth of the economy, as well as its affordable debt burden despite a continuous, gradual erosion of its economic and fiscal strength. The affirmation is also supported by renewed government commitment to accelerating the pace of structural reform, introducing a more consistent approach to economic policy, and proceeding with its budget saving plans.
That said, Moody’s decision to maintain a negative rating outlook reflects the rating agency’s view that the execution risks associated with implementing the government’s proposed structural reform initiatives are significant, given the strength of vested political interests that might oppose them and the poor track record in implementing such reforms.
In a related rating action, Moody’s has today announced its decision to maintain negative outlooks on the Aa1 ratings of Société de Financement de l’Economie Française (SFEF) and of Société de Prise de Participation de l’État (SPPE). The two entities’ Aa1 rating are affirmed, in line with the sovereign’s rating. Moody’s also affirmed the Prime-1 rating of SPPE, including its 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 OUTOOK
The main driver informing Moody’s decision to maintain the negative outlook on France’s Aa1 sovereign rating is the material possibility that the government’s fiscal and economic strength will continue to erode to levels not commensurate with an Aa1 rating. Moody’s assessment of a country’s economic strength rests not simply on its stock of wealth, but on its ability to replenish and grow that stock consistently over a sustained period of time — in other words, on its long-run growth rate.
Moody’s currently expects France to record real GDP growth of only 0.4% in 2014 and 0.9% in 2015, with growth accelerating to 1.4% by 2018. While the weak economic environment in the euro area has contributed to France’s lacklustre economic performance, the country’s growth rate has declined steadily in recent years, from around 2% on average in the years leading up to the global financial crisis, to just over 1% on average over the next four years. In Moody’s view, that decline partly highlights a gradual loss of competitiveness, as reflected in its falling export market share over the last decade, which in turn is to some extent attributable to structural rigidities in the French economy that have not been addressed by successive governments.
The negative outlook also reflects the significant execution risks associated with France’s structural reform programme. While the new government’s more vigorous approach to pursuing structural reforms is a positive step, the path to actually legislating and implementing these reforms is unlikely to be straightforward. Experience suggests that the government will face formidable obstacles in pushing through its reform programme in the face of vested political and economic interests. Moody’s therefore expects the execution risks facing these initiatives to rise with every stalled attempt at reform.
A further factor supporting the negative outlook on France’s Aa1 sovereign rating is the underlying and continued trend of deficit overruns and weak growth, which is causing France’s debt burden to increase beyond levels targeted a few years ago. The Finance Ministry recently announced that the general government deficit would increase to 4.4% of GDP in 2014 followed by a slight decline to 4.3% of GDP in 2015. Moreover, the French government says it will only reach the Maastricht deficit threshold of 3% of GDP in 2017, and even then the slow pace of fiscal consolidation through 2015 means that this milestone is, in Moody’s view, only likely to be reached in 2018. In addition, Moody’s forecasts that France’s debt-to-GDP ratio will continue to rise, breaching the 100% of GDP mark and continuing its upward momentum more gradually through to 2018, at which point it is expected to reverse.
Overall, the gradual erosion of France’s economic strength has mirrored a secular decline in fiscal strength. The French government’s debt burden has increased gradually but materially over the past two decades, with high and rising taxation being outpaced by ever-higher levels of social and other expenditure. Both tax and expenditure levels are high compared to France’s regional and rating peers, and with taxation probably at the limit of what the French population is prepared to bear, successive governments have come under increasing pressure to cut the growth of government spending.
RATIONALE FOR RATING AFFIRMATION AT Aa1
Moody’s decision to affirm France’s Aa1 sovereign rating reflects its view that the country retains very significant credit strengths, which support the high rating level. The French economy is large, productive and highly diversified, and exhibits significant wealth in terms of GDP per capita and moderate levels of household indebtedness. France retains strong institutions, scoring highly on World Bank Governance Indicators of Government Effectiveness and Rule of Law. Fiscal metrics, though eroding, remain consistent with those of Aa1-rated peers, and the government’s debt burden remains highly affordable with very low funding costs, reflecting a strong and deep investor base and a very favourable low yield environment (which is expected to dissipate only very gradually over time).
The affirmation of France’s Aa1 rating also reflects renewed commitment of the new government to accelerate the pace of structural reform, to introduce a more consistent approach to economic policy, and to proceed with its budget saving plans, which have the potential to gradually improve its fiscal position over the medium term. The government’s historically weak popularity levels reflect the pressures it faces, but the recent parliamentary confidence vote has reaffirmed its legislative mandate to implement a range of potentially growth-enhancing reforms that could address some important rigidities in the economy if they are vigorously pursued.
While France’s economic and fiscal strength remain, for now, at levels consistent with its current rating level, it faces challenges in retaining that rating level. France’s ability to avoid a downgrade over time and return to a stable rating outlook will rest on the government’s ability to reverse the long-term erosion of the French economy’s competitiveness, and to implement budget saving plans to bolster its eroding fiscal strength. Since François Hollande was elected in May 2012, the French government has taken some steps to implement structural reforms designed to reverse the erosion of competitiveness and correct budget imbalances. However, the pace of reform has remained slow, as it had been under previous administrations, and the achievements to date have not been sufficient to reverse the slowing growth trend or to achieve material improvements in fiscal metrics. If France does not return to its previous trend growth rate of around 2% until the end of this decade, if at all, its debt-to-GDP ratio could continue to rise.
WHAT COULD MOVE THE RATING DOWN/ UP
Moody’s would likely downgrade France’s government debt rating if the rating agency’s confidence in the government’s ability to undertake the necessary fiscal consolidation measures and structural economic reforms were to decline further over the next 12 months, or if those measures were to be delayed or diminished in scope or ambition. Further deterioration in the government’s fiscal metrics beyond the rating agency’s current expectations would also likely lead to a downgrade of the rating.
Moody’s would consider moving the outlook to stable on France’s government debt rating should the rating agency conclude that the planned economic reforms and fiscal measures will be implemented and effective in strengthening both growth and the government’s balance sheet.
GDP per capita (PPP basis, US$): 35,784 (2013 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 0.2% (2013 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 0.8% (2013 Actual)
Gen. Gov. Financial Balance/GDP: -4.3% (2013 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -1.3% (2013 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