Heightened French risk still imperilling the eurozone

The fall in French creditworthiness since 2008 is well-documented.

Languishing 23rd in ECR’s global rankings of 186 countries worldwide, on a total risk score of 69.9 points from a maximum 100, as of late November, France is now 11.5 points and 12 places lower than Germany and its debt can be insured accordingly based on a larger CDS risk-premium spread.

France is now barely six points higher than Ireland, the highest-ranking of the debt-burdened periphery, which sought bailouts, but are now rebounding in Euromoney’s survey thanks to fiscal reforms and a return to economic growth.

The eurozone’s second-largest economy, by contrast, has toppled from a tier-one, triple-A rated sovereign to tier two, putting it within the A- to AA rating bracket.

Fitch and Moody’s are poised to downgrade their AA+/Aa1 ratings for France, placing them on a par with S&P’s, though that might not be the last of it.

Core problems

The French economy, like Italy’s, has been flat-lining in recent years, relying on government consumption in 2013 to offset lacklustre consumer spending, contracting investment and a negative trade balance as import volume exceeds what moderate export growth there has been to date.

President François Hollande’s Socialist Party government believes slackening off on austerity is the only answer to engineering a sustainable, broad-based recovery, alongside the monetary stimulus soon to be bolstered by quantitative easing from the European Central Bank.

Encouragingly, economic activity improved during the third quarter, with GDP rising in real terms by 0.3% quarter-on-quarter and 0.4% year-on-year. Some economists believe this might just be the beginnings of the long-anticipated turnaround in the nation’s fortunes.

Head of economics at Natixis Sylvain Broyer sees GDP growth improving over the next quarters, arguing that “depreciation of the euro and the drop in oil prices have launched a positive shock for the terms of trade that will bolster consumption and exports”.

The latest French bank lending survey, moreover, signals improvement in the credit cycle, which with an end to falling corporate profits, stemming in part from reforms tackling unit labour costs, should stop the decline in investment spending.

Yet others point to fundamental structural issues undermining France’s prospects.

M. Nicolas J Firzli, director-general of the Paris-based World Pensions Council, says: “It is hard to see how the country’s slow, numbing and seemingly inexorable decline can be stopped in the short-to-medium term.

“The cost structure of most French industrial and service-sector firms is simply too high, the jobs market too rigid, the fiscal pressure too great and the political base of the current, centre-left government far too narrow for any meaningful turnaround.”

The government is running a gross fiscal deficit – on an EU basis – exceeding 4% of GDP, which is unlikely to fall below that level before 2017, according to the latest forecasts from the Organization for Economic Cooperation and Development (OECD).

That scenario, based on higher growth than France has managed this year, still sees gross government debt – also on an EU basis – rising above 100% of GDP by 2016, putting France in a small but expanding club of eurozone nations (with Greece, Italy, Ireland, Belgium and Cyprus) already grappling with double-digit sovereign debt burdens.

Monetary stimulus has seen bond yields fall to record lows. The French 10-year yield settled at just 1.05% this week, but borrowing costs could rise again if the markets take fright.

Deflation poses a substantial risk to debt-reduction plans. Harmonized consumer prices rose by just half a percent in the year to October in France. Other parts of Europe are already experiencing negligible inflation, or even deflation.

Political impediments

France has the second-highest government spending among OECD countries, but with no political will to carry through meaningful improvements owing to the government’s delicate position.

With an economy so weak for so long, the far-right National Front stormed to victory at the European elections in May. The Socialists have, moreover, lost the support of their Green Party allies, while alienating the left without attracting support from a divided centre.

The unemployment rate driving the political agenda has continued to rise this year, stabilizing at 10.5% in recent months, which is double the level in Germany and with around a quarter of the workforce under the age of 25 unable to find employment, heightening the risk of more public protests.

The government is walking a fine line. ECR experts have downgraded substantially the score for government stability this year, which is now the lowest of the six political risk indicators on 6.7 out of 10.

Norbert Gaillard, an independent consultant who has written extensively on eurozone sovereign credit risk, succinctly points to three main problems in France: “Uncertainty surrounding the 2017 presidential elections” in the context of the National Front’s rise; “the persistent decline in competitiveness”; and the government’s “incapacity to launch reforms to lower pensions, improve labour-market flexibility and cut the number of civil servants”.

Until these shortcomings are properly addressed, France’s country risk score is unlikely to rise.

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.