DBRS Confirms Republic of France at AAA, Stable Trend

DBRS Ratings Limited (DBRS) confirmed the Republic of France’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS confirmed the Republic of France’s 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, strong public institutions, and financing flexibility. The confirmation of the Stable trend reflects the government’s clear commitment to addressing the country’s structural challenges and its future macroeconomic outcomes. In DBRS’s view, recent revisions to the government’s debt and deficit targets do not reflect a retreat by authorities from their policy commitments. Notwithstanding setbacks associated with ongoing public protests, 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.

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. Further still, the trajectory of France’s public debt ratio has yet to peak and is expected to reach 98.9% of GDP in 2019. Even as the implicit cost of debt declines, 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, or (3) the planned decrease of the country’s high debt-to-GDP ratio.

RATING RATIONALE

Ongoing Protests Continue to Influence the Public Debate in France

Following the government’s first year in office – characterised by the successful passage of structural tax, labour and product market reforms – the country began to face new economic and political challenges last year that forced the government to alter macroeconomic targets. While the intensity of social tensions associated with the weekly gilets jaunes (yellow vests) protests have tempered since the initial outbursts in November 2018, the protests are still ongoing and have made their mark, principally, by forcing the government to adopt a more conciliatory political stance and to implement additional fiscal easing measures.

DBRS considers the government’s response to the protests thus far to have been effective, even as risks to the reform agenda remain. The government’s engagement strategy focused on a two-month nationwide series of community conversations, through a Great National Debate. In a speech that presented his initial conclusions of the debate, President Macron, among other details, reaffirmed his administration’s committement to reform, offered additional tax relief, and presented plans to reorganize the civil service. Effective engagement is best reflected by the rebound in the government’s approval ratings since the end of last year.

Difficult reforms are still pending and the legislative road ahead for the government is complex. The ambitious plans to transform the public administration and reduce the large number of civil servants remain incomplete. The President conceded that reducing the civil service by the initially targeted 120,000 positions by 2022 is unlikely to occur. Difficult discussions are also underway to reform the unemployment insurance scheme and the pension system. Despite the government’s parliamentary majority, current social and political realities pose persistent reform challenges.

The French Economy is Expected to Outperform the 2019 Eurozone Average, Even with Downward Growth Revisions

Domestic and foreign headwinds have led to downward growth revisions to the French economy. Following growth of 2.2% in 2017 and 1.6% in 2018, the 2019 Stability Programme assumes growth of 1.4% in each year from 2019-2022. This growth performance would still remain above output potential and outpace the Eurozone average this year.

Domestic demand is being weighed down by slower investment growth, while demand is supported by favourable developments in wage and employment growth. The direct impact of the protests on the economy has so far been limited, estimated by INSEE to have shaved only 0.1pp off 2018’s fourth quarter output. Yet, the longer the protests persists, the more they weigh on economic confidence and complicate the reform agenda.

The outlook for exports is also uncertain. External demand has slowed due to the weaknesses among other large European countries, persistent threats of US-centred trade conflicts, and the ongoing Brexit delays. Nonetheless, France has no noticeable external imbalances. It recorded manageable 2018 deficits in the current account balance (0.3% of GDP) and the international investment position (11.4% of GDP). The country has a highly open economy with extensive trade, investment and financial linkages throughout Europe and around the world.

Recent Economic and Political Challenges Led to New Spending and Temporary Fiscal Slippage in 2019

The deficit is expected to temporarily breach the 3% of GDP threshold in 2019 for two reasons. First, the deficit increases this year due to a planned transformation of the Competitiveness Tax Credit (CICE) into a permanent reduction in employer social security contribution. This has a 2019 fiscal cost of 0.9% of GDP. The change is meant to lower the labour tax wedge to improve labour flexibility and business competitiveness. Budgetary under-execution last year allowed the deficit to decline to 2.5% and the 2019 Stability Programme expects a 3.1% deficit this year. Second, the deficit widens beyond previous expectations (the 2019 Budget had anticipated a 2.8% deficit in 2019) as a result of slower growth and additional spending adopted in late 2018 to quell the public protests. Including the fiscal expansion and excluding the CICE one-off, the deficit would be 2.3% in 2019 and the government expects a 1.2% deficit by the end of the forecast period in 2022.

Progress in reducing the structural balance has stalled. The structural deficit as a percentage of potential GDP has seen limited improvement since 2017 and is expected to remain above 2% in 2019. France has one of the highest structural deficits in the eurozone. While France remains distant from its structural deficit medium-term objective (MTO) of 0.4% of potential GDP, the government expects the structural deficit to begin to decline in 2020 and reach 1.3% of potential GDP by 2022. DBRS considers successful repair of the structural balance as critical for France to fortify its fiscal anchor and place its debt on a more accelerated downward trajectory.

France has Little Difficulty Financing its High Debt Ratio

France’s debt ratio remains among the highest in its peer group. According to the 2019 Stability Programme, public debt is expected to peak in 2019 and decline only gradually to 96.8% of GDP by the end of the forecast period. France’s high debt burden reduces the country’s ability to respond to future shocks. Nonetheless, France’s prudent debt management strategy helps mitigate risk. Debt managers can count on a broad investor base and yields have so far been unresponsive to recent fiscal and economic revisions and remain 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 8 years for central government debt.

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. Combined household and nonfinancial sector debt increased by roughly 25 percentatge points of GDP to around 130% in the decade to the third quarter 2018, according to the Banque de France. Net of offsetting liquid assets, the evolution of private sector indebtedness appears relatively contined.

A main challenge for the French financial system has been to operate in an environment of low interest rates. 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 the impact of current protests on France’s fiscal outcomes, and progress on the reform agenda.

KEY INDICATORS

Fiscal Balance (% GDP): -2.5 (2018); -3.1(2019F); -2.0 (2020F)
Gross Debt (% GDP): 98.4 (2018); 98.9 (2019F); 98.7 (2020F)
Nominal GDP (EUR billions): 2,351 (2018); 2,423 (2019F); 2,499 (2020F)
GDP per Capita (EUR): 34,885 (2018); 34,895 (2019F); 35,796 (2020F)
Real GDP growth (%): 1.6 (2018); 1.4 (2019F); 1.4 (2020F)
Consumer Price Inflation (%): 1.8 (2018); 1.3 (2019F); 1.3 (2020F)
Domestic Credit (% GDP): 256.8 (2017); 251.4 (Sep-2018)
Current Account (% GDP): -0.3 (2018); -0.5 (2019F)
International Investment Position (% GDP): -20.1 (2017); -11.4 (2018)
Gross External Debt (% GDP): 210.7 (2017); 217.1 (2018)
Governance Indicator (percentile rank): 88.0 (2017)
Human Development Index: 0.90 (2016); 0.90 (2017)

EURO AREA RISK CATEGORY: LOW

Notes:

All figures are in Euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Fiscal and debt ratios, real GDP, and CPI taken from 2019 Stability Programme. Nominal GDP and GDP per capita from INSEE. External data from Banque de France and INSEE. 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 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.

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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: November 9, 2018

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