Moody's Downgrades France, Blames "Political Constraints", Sees No Material Reduction In Debt Burden

The key interrelated drivers of today's action are:

At the same time, France's credit worthiness remains extremely high, supporting an Aa2 rating. The country's significant strengths include: (i) a large, wealthy, and well-diversified economy with a high per capita income, (ii) favourable demographic trends as compared to other advanced economies, and (iii) a strong investor base and low financing costs. The rating and its stable outlook are also supported by the country's efforts to stabilise its public sector finances and initiatives recently deployed or announced to arrest the erosion of the economy's competitiveness.

In a related rating action, Moody's has today announced its decision to downgrade the ratings of the Société de Prise de Participation de l'État (SPPE) to Aa2 from Aa1. The SPPE's short-term rating was affirmed at P-1, including its euro-denominated commercial paper programme. The outlook on the ratings is stable. The debt instruments issued by the SPPE are backed by unconditional and irrevocable guarantees from the French government.

The local and foreign currency deposit ceilings and the local-currency and foreign-currency bond ceilings for France are unaffected by this rating action and remain at Aaa/P-1.

The main driver of Moody's decision to downgrade France's government bond rating to Aa2 is the increasing clarity, in Moody's view, that French economic growth will remain low over the medium term, and the obstacle that this will pose for any material reversal in France's elevated debt burden in the foreseeable future.

The current economic recovery in France has already proven to be significantly slower -- and Moody's believes that it will remain so -- compared with the recoveries observed over the past few decades. In part, this is due to the erosion of competitiveness and loss of growth potential following the global financial crisis. It is becoming increasingly clear, in the rating agency's view, that these problems will continue to constrain growth long after the cyclical recovery from the crisis is completed. In Moody's opinion, France's potential annual growth rate is at most 1.5% over the medium term. France faces material economic challenges, such as a high rate of structural unemployment, relatively weak corporate profit margins, and a loss of global export market share that have their roots in long-standing rigidities in its labour and product markets.

France entered the crisis with a legacy of sustained, very high levels of state expenditure and a history of recurring budget deficits that goes back four decades. A pattern that has become evident over time has been that French public sector debt, relative to GDP, essentially stabilises in good times and rises in bad. The rise in indebtedness since the onset of the crisis has been very rapid and the country's debt burden will likely peak and stabilise at around or close to 100% of GDP. Notwithstanding the magnitude of the fiscal and economic challenges that the government faces, the institutional response since the onset of the crisis has been slow and halting, essentially consisting of a series of small positive steps that have, individually and collectively, been insufficient to deal with these challenges in a timely manner. Within the context of Moody's sovereign rating methodology, a government's institutional willingness and ability to reverse the impact of shocks on the public finances is an important attribute associated with very high rating levels. While Moody's assessment of the quality of France's institutions remains very high, the rating agency does not believe that the country's institutional strength is on a par with many of the most highly rated sovereigns.

Taken together, low growth and institutional and political challenges to reforms make it unlikely that we will see a material reduction in the government's high debt burden over the rest of this decade, which means that it will remain well above the debt burdens of Aa1-rated peers. The combination of structurally weaker growth, low inflation, and a more than 30 percentage point increase in the debt/GDP ratio since the onset of the global financial crisis means that the shock absorption capacity of France's balance sheet has weakened and, in Moody's view, is no longer expected to recover materially in the next three to five years.

The stable outlook on France's Aa2 sovereign rating partly reflects the strengths that underpin the Aa2 rating itself--the underlying economic and fiscal strengths of the French sovereign. France is a large, wealthy and well-diversified economy that is home to a significant number of companies in high-value added sectors. Income inequality is relatively low. Relative to other advanced economies, France has a favourable demographic profile, and is not expected to see a contraction in the size of its working age population over the long term. The government's current interest burden (both as a percentage of revenues and as a percentage of GDP) does not represent a significant constraint on the public finances. Efforts are being taken to reduce the budget deficit, albeit at a materially slower pace than was envisioned as recently as the 2014 Stability Programme.

The stable outlook also recognises the French government's stated desire to address some of the structural challenges to growth and the fiscal balance, which should at least protect its balance sheet from further deterioration. While the revealed preference of French institutions is to undertake incremental, gradual change, the changes we expect in these areas--for example, though a second Macron Law and a revision to the labour code--between now and national elections in 2017 should prevent a further material deterioration in French credit quality over this time horizon.

As reflected by the stable rating outlook, Moody's does not anticipate any movement in the rating over the next 12-18 months. However, downward pressure on the rating could arise if progress on structural macroeconomic reform were to fail to materialise as we expect. Moody's could also downgrade France's government debt rating further in the event of a reduced political commitment to fiscal consolidation or should we conclude that a material increase in debt was likely for any other reason.

Conversely, Moody's would consider changing the outlook on France's rating to positive, and ultimately upgrading the rating back to Aa1 in the event of much more rapid economic growth and debt-to-GDP reduction than Moody's is currently anticipating.

On 15 September 2015, a rating committee was called to discuss the rating of the France, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially decreased. The issuer's institutional strength/framework, have materially decreased. The issuer's fiscal or financial strength, including its debt profile, has materially decreased. An analysis of this issuer, relative to its peers, indicates that a repositioning of its rating would be appropriate.