Rationale
The downgrade reflects our view that the French government's current approach to budgetary and structural reforms to taxation, as well as to product, services, and labor markets, is unlikely to substantially raise France's medium-term growth prospects. Moreover, we see France's fiscal flexibility as constrained by successive governments' moves to increase already-high tax levels, and what we see as the government's inability to significantly reduce total government spending.
The stable outlook reflects our expectation that the government is committed to containing net general government debt, which we anticipate will peak at 86% of GDP in 2015. The stable outlook also indicates that we currently believe that the probability of a further rating action on France over the next two years is less than one-in-three.
In our opinion, the economic policies the government has implemented since we affirmed the ratings on France on Nov. 23, 2012 have not significantly reduced the risk that unemployment will remain above 10% until 2016, compared with an average of 8%-9% prior to 2012. In our view, the current unemployment levels are weakening support for further fiscal and microeconomic reforms, and are depressing longer term growth prospects. France's real economic output rebounded to the levels reached in the fourth quarter of 2007 only in 2013. We are projecting close-to-zero real GDP growth this year, followed by a cyclical recovery to an average of just over 1% for 2014-2015.
The steps the government has taken so far--such as introducing corporate tax credits on firms' payrolls, and reaching agreement on labor market reforms and microeconomic reforms to specific sectorsare positive, in our view, but probably insufficient to significantly unlock France's economic growth potential. In particular, we think private-sector growth is unlikely to improve substantially without further structural reforms. While the government has taken steps toward microeconomic reforms, the overall effect appears to us to leave France with less economic flexibility than other highly-rated eurozone members. As a consequence, French exporters appear to continue to be losing market share to those European competitors whose governments have more effectively loosened the structural rigidities in their economies.
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Since it took office in May 2012, the current French government has started to strengthen its fiscal framework by implementing a multiannual public finance planning act and establishing a high council for public finances. However, it has also relaxed its headline budgetary targets due to the deteriorating economic background.
Successive governments' stated commitment to budgetary consolidation has relied on increasing an already-high tax burden. We estimate France's general government revenue will remain at over 53% of GDP through to 2015 (compared to below 50% prior to 2011), the highest ratio of an OECD member outside the Nordic region. We project general government spending will stay above 56% of GDP over the same period, the highest in the eurozone and only surpassed by Denmark within the OECD. We understand that the government aims to reduce government spending, in line with the 2012-2017 public finance programming law. However, we believe that the effect of the government's measures to this end--both announced and already taken--will be relatively modest.
At the same time, political room for additional revenue measures has lessened, in our opinion. Rising popular disapproval of incremental taxation has led to recent policy reversals. Combined with our view that the government has limited room to meaningfully lower spending over the 2013-2016 forecast horizon, we believe that France's revenue and expenditure flexibility has diminished. We had previously considered France's fiscal flexibility to be high compared to its peers. We now forecast a general government deficit of 4.1% of GDP in 2013, in line with the government's current target but above our previous expectation of 3.5% of GDP when we affirmed our ratings on France in November 2012. At that time, the government's 2013 target was 3% of GDP.
We estimate net government debt will peak at over 86% of GDP in 2015. We also forecast gross debt at above 93% of GDP by end-2015, excluding the guarantees related to the European Financial Stability Facility (EFSF).
The 'AA' ratings on France reflect our view of the French economy's underlying strengths, including its high absolute levels of wealth and productivity, its high diversification and resilience, supportive demographic dynamics, and financial sector stability. It also has what we consider to be high private-sector savings rates and incomes, reflecting a skilled and well-educated workforce, political stability, and the euro's reserve currency status. France also benefits from significant monetary flexibility as a core member of the eurozone. This has been evident in favorable external financing conditions for the sovereign and what we view as an effective transmission of appropriately low real interest rates on loans to the nonfinancial sector. At the same time, we consider that the currently historically low long-term government bond yields have temporarily reduced pressure on France's general government deficit.
The rating is constrained by the French government's elevated spending and tax levels, its high and still rising general government debt burden, and constraints on economic competitiveness. All these factors weaken France's growth prospects, in our opinion.
Outlook
The stable outlook indicates our view that risks to France's creditworthiness are balanced and that there is less than a one-in-three probability that we will raise or lower the ratings over the next two years.
We could lower the ratings if, contrary to our current expectations, France's general government deficit widened significantly compared to our current forecast; if we were to conclude that the government's commitment to contain public debt is weakening; or if contingent fiscal risks materialized, leading to net general government debt of more than 100% of GDP. We could also lower our ratings on France if we see a significant and unexpected increase in risks to financial stability from a further fracturing of financing conditions either within the eurozone or outside it.
We could raise the ratings if net general government debt fell below 80% of GDP or there were evidence of improved economic competitiveness and resultant growth substantially in excess of our current forecast.
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