- In our view, the French government’s budgetary position is deteriorating in light of France’s constrained nominal and real economic growth prospects.
- We believe that, due to policy implementation risk related to the budgetary consolidation and structural reforms, a recovery of the French economy could prove elusive and that France’s public finances might deteriorate beyond 2014, although this is not our base-case scenario.
- As a result, we are revising our outlook on France to negative from stable and affirming our ‘AA/A-1+’ long- and short-term sovereign credit ratings.
- The ratings on France remain supported by our view of the French economy’s high income per capita and productivity, its diversification, and its stable financial sector.
On Oct. 10, 2014, Standard & Poor’s Ratings Services revised its outlook on the Republic of France to negative from stable. At the same time, we affirmed our unsolicited ‘AA’ long-term and ‘A-1+’ short-term sovereign credit ratings.
The ‘AA/A-1+’ ratings remain supported by our view of the French economy’s high income per capita and productivity, reflecting a skilled and well-educated workforce and strong institutions. We also consider the substantial pool of private sector domestic savings, alongside relatively low household debt levels, to be supportive of public creditworthiness. In addition, we see the financial sector as adequately capitalized and well regulated, and highly unlikely to generate any fiscal costs for the French state.
The outlook revision reflects our view of receding fiscal space for the French government in light of the economy’s constrained real and nominal growth prospects against the background of policy implementation risk.
We now project French general government deficits for 2014-2017 will average 4.1% of GDP, against 3.2% as of April this year. At the same time, we have lowered our projections of average real economic growth to 1.2% over 2014-2017 against 1.3% previously. We have also cut our nominal average GDP forecasts to 2.0% on average from 2.5% for the same period. These changes have led us to revise upward our gross general government debt-to-GDP forecast to slightly above 98% in 2017 from our previous forecast of 95.5%. Correspondingly, we expect that net debt to GDP will increase to almost 92% in 2017 from our previous estimate of 89%. Our general government debt measure excludes the guarantees related to the European Financial Stability Facility (see “S&P Clarifies Its Approach To Accounting For EFSF Liabilities When Rating The Sovereign Guarantors,” published Nov. 2, 2011, on RatingsDirect). We estimate that methodological changes due to the adoption of ESA 2010 in September 2014 do not significantly affect these comparisons.
In line with our previous assumptions, the government is expected to miss its fiscal targets in 2014 (see “France ‘AA/A-1+’ Ratings Affirmed On Gradual Economic And Fiscal Adjustments; Outlook Stable,” April 25, 2014). Moreover, even taking into account the new methodological treatment of tax credits (due to the change to ESA 2010 from ESA 95), the expected slippage for 2014 is greater than we had previously anticipated, largely on the back of lower-than-expected revenues. The government is now expecting a budget deficit of 4.4% of GDP this year, versus its previous target and our previous estimate of 3.8% of GDP.
In our view, the weakening fiscal trajectory will likely only be lastingly reversed if the economy regains dynamism. In our opinion, past fiscal policies, which succeeded in moderating public deficits mainly by increasing the tax burden, have contributed to deter a meaningful recovery in the French economy.
In this context, we continue to forecast a modest cyclical recovery, with real GDP growth of 0.5% in 2014, 1.1% in 2015, and 1.5% in 2016-2017, against an average of 1% in 2010-2013 (see “Under Threat Of A Triple Dip, The ECB Takes Action,” Sept. 15, 2014). We project that private spending may only gradually replace public consumption as the key driver of economic growth, owing to gradually more favorable credit conditions, government spending constraints, and relatively moderate private sector leverage compared with other advanced economies. We consider most risks to our revised real and nominal GDP projections to be to the downside.
In 2013, total employment in France in absolute terms remained below pre-crisis (2007) levels, according to data from the official statistics office INSEE. While we consider that the tax credit measures introduced in 2013 and the reduction in employers’ social contributions, voted in 2014, should alleviate labor costs, and therefore support France’s growth potential and the economy’s competitiveness in the medium term, we are not confident that these alone will create sizable investment and employment growth. This is because the non-wage cost of employment–primarily social contributions and payroll taxes, but also the cost of redundancies–remains high according to Eurostat data. We understand that the government aims to gradually to lower these costs through its Responsibility Pact.
The government has stated its ongoing commitment to expenditure control and further supply-side reforms aimed at reinvigorating the economy, recovering French companies’ competitiveness, and lifting their relatively low profitability. Successful implementation of these measures could help stimulate private sector investment, which has been stagnating since 2012. The government’s agenda includes cutting red tape, increasing support of financing and innovation for small and midsize enterprises (SMEs), and reconsidering the regulatory constraints that constitute incentives to keep employee headcounts low. We understand that by the end of 2014, the government plans to introduce a more ambitious reform package in the product and services market, aiming, among others, at reforming regulated sectors, easing constraints on the housing sector, and reviewing laws on working on Sundays.
Our base case is that the government will continue to command a workable majority in the National Assembly. A cabinet reshuffle in August appears to have resulted in a more coherent government, potentially increasing the government’s resolve for implementation of reforms.
Nevertheless, we believe that implementation risks persist. This view is informed by what we consider to be the lack of a strong track record in structural policy implementation and the possibility of vocal opposition to many of the planned measures. Additional complicating factors include, in our view, high unemployment, which we expect to remain above 10% until 2017, and, according to opinion polls, an unpopular political leadership.
While we understand the arguments in favor of countercyclical stimulus, we continue to see France’s fiscal flexibility as increasingly limited, due to weak nominal GDP growth forecasts and given that France’s exchange rate is fixed versus those of most of its trading partners. Membership of the eurozone provides France with a strong monetary anchor, giving the economy access to funding at low nominal interest rates. We also believe that membership in a fixed exchange rate area increases the onus on member governments to both ensure fluid labor, product, and services markets, and to build up fiscal buffers against future shocks. This is more the case now than before given that the European Central Bank is undershooting its medium-term price stability target of close to, but below 2% for the euro area as a whole. Harmonized Indices of Consumer Prices (HICP) inflation in France in August was 0.5% year on year, while the core consumer price index (CPI) was 0.4% year on year. In this context, restoring fiscal buffers could prove difficult.
We consider that the French government is committed to containing public expenditure growth. This marks a departure from its initial revenue-based approach to budgetary consolidation. This should enable the share of expenditures in GDP to decline below 55% in 2017, from a peak of 57% in 2014 (which is the joint highest in the EU, alongside Denmark, according to Eurostat data). We understand the savings may result from measures such as a temporary freeze in social security benefits, a civil service wage index freeze until 2017, a reduction in state transfers to local and regional governments, and discretionary cost-reduction measures in the health care system.
We believe that the government’s projections of general government revenues could, however, prove too optimistic in a context of lower-than-projected nominal GDP growth (the government’s underlying nominal GDP growth assumption is 3.65% in 2017, versus 0.9% in 2014). At the same time, we understand that the government is committed within the Responsibility Pact to support household consumption and companies’ competitiveness through reductions in tax and social contributions. These two factors have led us to believe the government is unlikely to reach the fiscal target of 3% of GDP in 2017, which is in the 2014-2019 public finance programming bill. Instead, we anticipate the general government deficit will likely remain at 3.6% in 2017 and we expect the change in general government debt to average almost 4% in 2014-2017. Even if successful, we believe that this fiscal adjustment strategy would still result in an exceptionally large public sector, which would require high levels of taxation that in turn could continue to depress investment, employment, and growth.
In this context of deficit overshoots and weak nominal GDP growth, we expect that net general government debt will continue to increase until at least 2017, and that debt stabilization will be further postponed.
The very low interest rate environment has contributed to keeping the general government gross interest payment burden below 5% of general government revenues, despite a rising debt burden. We estimate that the effective general government nominal interest rate has dropped to 2.5% on average in 2014, from 4.7% in 2008. Over the medium term, we project that, even at current interest
rates, a higher percentage of revenues will go toward interest expenditures as the level of public debt continues to increase.
The negative outlook indicates our view that a robust recovery of the French economy could prove elusive and that France’s public finances could deteriorate beyond 2014.
The negative outlook signals that we consider that there is at least a one-in-three likelihood that one of the events below will occur and that we would therefore lower the rating within the next 24 months. Should we lower the rating, we would currently not expect to lower it by more than one notch.
Specifically, we could take a negative rating action if one of the following were to occur:
Fiscal deficits don’t recede as expected in 2016 and 2017, leading to a continuous rise of net general government debt ratios, in particular if lower-than-expected real growth and inflation rates depress the level of nominal GDP below the government’s assumptions. Monetary policy actions at the eurozone level fail to prevent the risk of outright deflationary pressures eroding France’s fiscal and growth performance. General government interest payments as a share of GDP rise persistently above 5% of general government revenues. The government does not succeed in implementing its reform program aimed at stimulating growth and employment over the medium term. This could signal policy implementation risks and weakened governance efficiency and ability to consistently conduct prudent and growth-enhancing policies.
Conversely, we could revise the outlook to stable if:
We assess that the net general government debt ratio would begin a sustained decline over 2014-2017. If GDP per capita growth significantly exceeds our current assumptions, which would indicate that France’s economic growth prospects were converging toward those of other high-income economies.