DBRS Confirms Republic of France at AAA, Stable Trend

DBRS Ratings Limited confirmed the Republic of France’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA and Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trends on all ratings are Stable.

KEY RATING CONSIDERATIONS

The ratings are underpinned by France’s wealthy and diversified economy, its strong public institutions, and the country’s financing flexibility. The confirmation of the Stable trend reflects the government’s clear commitment to improving the country’s future macroeconomic outcomes. In DBRS’s view, the recent upward revisions to debt and deficit targets do not reflect a retreat by authorities from previously stated policy commitments. DBRS expects the government to continue its push to implement ambitious structural reforms meant to improve France’s medium-term fiscal balance and reduce its public-sector debt ratio. Following the economic slowdown in the first half of 2018, DBRS expects a second half rebound due to supportive tax policy and healthy domestic demand.

The country’s strengths are principally offset by structurally high public expenditures and high public-sector debt. Even if the government is successful at reducing public expenditures in line with its current 2022 targets, public spending in France will still account for over half of nominal GDP and remain well above the EU average for public expenditures. High public spending can have lasting effects on productivity and economic growth potential. Further still, reclassified debt related to the national railway company increased France’s debt to 98.5% of GDP in 2017. The high debt burden reduces the country’s ability to respond to future shocks.

RATING DRIVERS

Downward ratings pressure could emerge if adverse developments cause authorities to materially underperform on their current structural commitments, including: (1) the expected reduction in public expenditures as a share of GDP, (2) improvement in the structural fiscal balance, and (3) the planned decrease of the country’s high debt-to-GDP ratio.

RATING RATIONALE

Despite Downward Growth Revisions, Domestic and External Demand are Expected to Keep Growth above Potential

Influenced by a staggered implementation of tax policy, France’s economic performance in 2018 will likely be a tale of two halves. Weak private sector consumption and investment – weighed down in the first half of the year by slower external growth, tax increases and energy price rises – were the main drivers of slow 0.2% growth in each of the first two quarters. Boosted by the end of one-off factors and improvements in household purchasing power, the economy expanded in the third quarter by 0.4%. DBRS expects the growth momentum to slightly accelerate in the fourth quarter due to the expected positive impact on consumer spending from tax cuts and increases in social welfare scheduled for the second half of 2018. The government now expects real GDP growth of 1.7% in 2018 and 2019. Though slower than the 2.2% growth last year, the economy would still outperform measurements of economic growth potential (1.0-1.3%).

DBRS considers France’s external position resilient and, in the absence of external shocks, supportive of economic growth. The country has a highly open economy with extensive trade, investment and financial linkages throughout Europe and around the world. The long-term decline in France’s global export share reflects the competition challenge faced by all developed countries over the last two decades from emerging economies and some France-specific competitiveness challenges. Yet, French export shares have stabilised since 2012 and the total volume of French exports is at an all-time high. Recent forecast updates for 2018 point to manageable deficits in the current account balance (0.9% of GDP) and the international investment position (19.1% of GDP).

Upward Deficit and Debt Revisions Do Not Appear to Materially Derail the Government’s Medium-Term Fiscal Targets

Due to a technical reclassification of public debt and slower economic growth than expected in the 2018 Stability Programme (SP), the 2019 Budget increases debt and deficit forecasts for 2018 and 2019. France’s debt is now expected to peak at 98.7% of GDP in 2018, up 2.3 percentage points from the SP estimates due primarily to the reclassification of debt held by SNCF Réseau (national railway infrastructure) onto the government balance sheet. The SNCF debt consolidation also affected fiscal deficit results, increasing the deficit by 0.1 percentage point each year since 2016. Along with slower growth, the deficit was revised to 2.6% in 2018 and 2.8% in 2019, up from previous estimates of 2.3% and 2.4%.

The revisions do not, however, appear to have altered the government’s medium-term fiscal targets. The widening of the 2019 deficit is attributed to the transformation of the Competitiveness Tax Credit into a permanent reduction in employer social security contribution, which has a fiscal cost of 0.9% of GDP next year. The change is meant to lower the labour tax wedge to improve labour flexibility and business competitiveness. Excluding the one-off, the 2019 deficit would be 1.9% of GDP. The government still expects to bring the deficit to near balance by the end of its term and appears committed to the more than 3-percentage points of GDP reduction in the expenditure-to-GDP ratio (to 51.8%, excluding tax credits) and the 5-percentage point reduction in the debt-to-GDP ratio (to 92.7%) from 2017 to 2022.

France’s debt ratio remains among the highest in its peer group. In a context where the European Central Bank gradually increases interest rates, France’s high debt burden reduces the country’s ability to respond to future shocks. The French Treasury nonetheless has a strong funding profile. Debt managers can count on a broad investor base and yields have so far remained at favourably low levels. Even as medium-term interest rates rise, government stress testing shows the debt trajectory is resilient to interest rate shock scenarios. DBRS expects interest costs to increase only gradually due to the long debt maturity profile of 7.8 years for central government debt as of September 2018.

Risks to the underperformance of public finance stem primarily from high structural spending. The government expects a 2.0% of potential GDP structural deficit in 2019, a 0.3 percentage point improvement in the structural effort from 2017. Despite the progress, the structural balance is expected to remain in deficit long after the economic output gap is expected to turn positive in 2019. This illustrates the persistent cost pressures to the French social protection model. To meet expenditure targets, the multiyear Public Finance Plan Law for 2018-2022 aims to reduce the growth rate of public spending in real terms to an average of 0.2% per year over the period, compared to the average real expenditure growth rate of 1.5% from 2003-2017. DBRS considers compliance with expenditure growth targets difficult if the government is unable to deliver on forthcoming reforms that structurally reduce public sector spending.

Notwithstanding the Recent Passage of Important Reforms, the 2019 Reform Agenda Appears Challenging

DBRS considers reforms implemented during the first fifteen months of the Macron administration as positive. Changes have been made to tax policy and to the labour code, and new measures address some product market inefficiencies, including reform to the railway sector and to the reduction of administrative burdens. These are key to improving the long-term growth prospects of the French economy.

Critical reforms scheduled for next year are politically sensitive and will likely come up against resistance. To reduce the high level of public spending, the government plans to adjust the unemployment insurance system, simplify and homogenise the pension system, increase efficiency of healthcare spending, and reduce the large number of civil servants. Successful delivery of these pending reforms could be challenged by growing public discontent, most apparent by the administration’s declining favourability ratings. Public approval of President Macron declined to 29% according to a November 2018 Ifop-Fiducial poll, down from 48% in February 2018. That said, the government has kept on track with the initial reform calendar, and the parliamentary majority cannot be challenged until the 2022 general election. France’s institutional strength is evident by its high marks on World Bank governance indicators.

Risks to Financial Stability Appear Manageable

The banking sector appears well positioned to support economic growth. Bank balance sheets have strengthened, and credit conditions remain broadly supportive of the economic recovery. Low domestic interest rates and strong confidence indicators have helped spur credit growth. The increase in private sector debt is still worth monitoring. Latest available 2017 Banque de France data show household debt to disposable income increased to 91%, from 70% a decade earlier. Debt outstanding of non-financial corporations increased to 72% of GDP, from 53% over the same period. Yet, non-financial corporate debt net of cash deposits and intercompany lending is only around 45% of GDP according to a December 2017 INSEE study. This suggests some debt proceeds have been used to accumulate liquid financial assets.

A main challenge for the French financial system has been to operate in an environment of low interest rates. The expected rise in interest rates is a welcome development for bank profitability over the medium-term. Bank margins have been squeezed by declining lending rates to households and corporates, in a context of regulated deposit rates. Then again, a sudden increase in interest rates could have negative effects on bank asset quality, stemming from the increase in private sector indebtedness. Risk is nevertheless limited by stable leverage to equity ratios in the corporate sector, solid capitalisation of French banks, and effective macroprudential measures.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AAA to AA range. The main points discussed during the Rating Committee include economic performance, fiscal outcomes and the reform agenda.

KEY INDICATORS

Fiscal Balance (% GDP): -2.7 (2017); -2.6 (2018F); -2.8 (2019F)
Gross Debt (% GDP): 98.5 (2017); 98.7 (2018F); 98.6 (2019F)
Nominal GDP (EUR billions): 2,293 (2017); 2,356 (2018F); 2,431 (2019F)
GDP per Capita (EUR): 34,140 (2017); 34,950 (2018F); 35,901 (2019F)
Real GDP growth (%): 2.2 (2017); 1.7 (2018F); 1.7 (2019F)
Consumer Price Inflation (%): 1.0 (2017); 1.8 (2018E); 1.4 (2019F)
Domestic Credit (% GDP): 256.8 (2017); 254.8 (Jun-2018)
Current Account (% GDP): -0.6 (2017); -0.9 (2018F); -0.7 (2019F)
International Investment Position (% GDP): -20.1 (2017); -19.1 (Jun-2018)
Gross External Debt (% GDP): 210.7 (2017); 221.9 (Jun-2018)
Governance Indicator (percentile rank): 90.9 (2016); 88.0 (2017)
Human Development Index: 0.90 (2016); 0.90 (2017)

EURO AREA RISK: LOW

Notes:

All figures are in Euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development. The above European Commission estimates for the current account deficit do not reflect Banque de France data revision released in April 2018. The current account deficit was 0.6% in 2017 according to the revision.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include Ministry of Economy and Finance, Insee, Banque de France, Agence France Tresor, High Council on Public Finances, IMF, World Bank, UNDP, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Sovereign Ratings
Initial Rating Date: May 12, 2011
Last Rating Date: May 11, 2018

DBRS Ratings Limited
20 Fenchurch Street
31st Floor
London
EC3M 3BY
United Kingdom
Registered in England and Wales: No. 7139960

Information regarding DBRS ratings, including definitions, policies and methodologies, is available on www.dbrs.com.