The decision precipitated a memorable outburst by Christian Noyer, the governor of the Central Bank of France, who argued that the UK deserved to be downgraded before France due to its weaker economic fundamentals. His comments focused attention on the comparative states of the French and British economies amid the intensification of the crisis in the eurozone.
In Euromoney’s Country Risk Survey, France has consistently received higher (ie less risky) scores from economists than the UK across a range of economic and political indicators, suggesting that the views of analysts are largely supportive of M Noyer’s comments.
Perceptions of the creditworthiness of the UK and France have been strongly influenced by the deepening crisis in the eurozone. While France has suffered because of its banks’ heavy exposure to southern Europe, in particular Italy, and doubts about its fiscal credibility, the UK has benefited from its autonomous monetary policy and its steadfast commitment to fiscal austerity.
While France is increasingly perceived as the most vulnerable economy in the core of the eurozone, the UK retains its safe-haven status. At the beginning of 2011, the spread of 10-year gilts over German bunds was slightly higher than that of its French equivalent. At the end of 2011, gilts were more or less on a par with bunds while 10-year French bonds were trading at 134 basis points over Bunds.
France is preparing the ground for the loss of its triple A rating. It has experienced a mostly externally driven deterioration in its perceived creditworthiness because of its banks’ exposure to Italy and the size of its guarantees to the EFSF. France’s creditworthiness is more adversely affected by the intensification of the eurozone crisis.
The UK’s triple A rating is more secure, mostly on qualitative grounds. However, Britain’s fiscal position and its private sector balance sheet are in a far worse state than France’s. If it wasn’t for the UK government’s fiscal credibility and its independent monetary policy, the UK’s triple A rating would be much more at risk.
French public finance statistics have improved in 2011, more so than those of the UK. One, therefore, has to have a certain degree of sympathy with French officials who recently argued that it is the UK that should lose its triple A rating and not France.
However, any serious analysis of the eurozone crisis reveals that it is now less of a sovereign-debt crisis and more a crisis of confidence in the single currency. The UK has a proper currency and a proper central bank. France – and all other eurozone countries – do not have a normal currency and do not have a proper central bank. Moreover – this is the worst part – the French and German governments have failed to grasp the fundamental flaws in the design of the euro.
The main problem with the ECB is that it is not allowed to lend to governments of member states. Eurozone governments are therefore forced to resort to financial markets to (re)finance their debt.
This would not have been much of a problem if markets were able to price all risks efficiently. This is frequently not possible, not just because markets are subject to psychological biases, herding, fads, bubbles, etc, but also because certain events are rare and do not lend themselves to risk analysis.
Relying on markets to (re)finance sovereign debt when uncertainty and ambiguity aversion are rampant goes beyond placing too much faith in inefficient markets. It is sheer madness. Reluctance to turn the ECB into a normal central bank is, therefore, an act of recklessness that can further undermine confidence in the euro.
I would therefore not be at all surprised to see France – and even Germany - losing its triple A rating soon.