Scope affirms the French Republic’s long-term credit rating at AA with Stable Outlook
Scope Ratings GmbH has today affirmed the French Republic’s long-term issuer and senior unsecured local- and foreign-currency ratings at AA with a Stable Outlook. The short-term issuer ratings have been affirmed at S-1+ in both local and foreign currency with a Stable Outlook.
Scope’s affirmation of the French Republic’s AA ratings reflects its large and diversified economy with a recent track record of structural reforms and high private and public sector investment, which bolster the country’s moderate growth potential. The ratings also benefit from the country’s favourable debt structure with a long average maturity of around 8 years and low refinancing rates. At the same time, the rating is constrained by high public debt, persistent fiscal deficits and labour market challenges. The Stable Outlook balances Scope’s expectation of a continuation of the reform programme over the medium run with public debt levels that are set to remain high, although on a downward trajectory from 2020 onwards according to the government’s medium-term strategy.
Following a period of stagnation with low growth potential (of around 1% p.a.) and real annual growth averaging only 0.8% between 2012 and 2016, growth in France picked up in 2017 (to 2.3%) before moderating to 1.6% during 2018 in line with a weaker global environment. In 2019, Scope expects a moderation of economic growth towards 1.3%, below previous projections but above the euro area average. Scope anticipates that a rebound in domestic consumption will drive the expansion, supported by growth-enhancing fiscal measures alongside an improving labour market. Business investment is projected to remain dynamic on the back of labour market reforms and favourable financing conditions. Compared with 2018, lower export growth driven by weaker global growth and ongoing economic and political uncertainty related to gilets jaunes social protests could weigh on the growth outlook.
The French government under President Emmanuel Macron has enacted major supply-side oriented reforms designed to stimulate the country’s growth. Among them, tax cuts for employers and employees reduced ancillary wage costs and a reform of the tax system has targeted reductions in distortive, low-revenue taxes (i.e. the wealth tax) while at the same time broadening the tax base via an increase in the CSG solidarity tax rate. Scope expects that these measures have lifted France’s medium-run growth potential by around 0.2% and were already reflected in higher-than-expected growth since the second half of 2018.
Despite the French economy’s inherent credit strengths, including the aforementioned reform efforts of President Macron, Scope identifies two key vulnerabilities, specifically related to i) the persistent labour market challenges and ii) elevated public debt levels and ongoing fiscal deficits.
First, notwithstanding the government’s efforts aimed at unlocking the labour market’s full potential, the high level of labour costs continues to prevent a faster trend rate of employment growth, especially among low-skilled segments of the labour force. The low level of youth employment (according to Eurostat 74.4% for the 20-34 year old cohort with at least an upper-secondary-level education) points to existing deficiencies in the education system, reflected also in PISA test rankings in 2015 that showed France faring worse than peers on reading, maths and science among 15-year-olds. It is Scope’s view that these weaknesses in the education system underscore the importance of the government’s reform initiatives, with particular attention on training for the low-skilled population and immigrant groups. Still, Scope notes that a set of educational reforms has been undertaken recently in order to lower the age of compulsory schooling to 3 years old, halve the sizes of 1st and 2nd grade classes in priority education networks REP and REP+, and reform the baccalaureate and access to university.
Second, on the fiscal side, the government has reduced or abolished several distortive, low-revenue taxes while at the same time broadening the tax base. The abolition of the solidarity wealth tax, introduction of a flat tax on capital income, progressive exemption of 80% of the population from a housing tax with a view to exempt 100% by 2022, and gradual reduction of the corporate tax rate from 33% to 25% in 2022 could support economic growth over the medium-term. To compensate for the loss in tax revenues, the government has increased the CSG solidarity tax rate, both of which cover a broader tax base and thus have a less distortionary impact on economic activity.
While Scope acknowledges the positive impact of the tax reform on the economy and, in the end, fiscal revenues, authorities have postponed reforms to the structure of fiscal expenditures. Additional planned tax hikes on energy have moreover been cancelled after the yellow vests protests. France remains the country with the highest expenditure to GDP ratio in the euro area at 56.2% (Eurostat 2018), currently projected to decrease only gradually to 54.1% by 2020. Close to 50% of total expenditures relate to social security spending (pensions, health), followed by compensation of employees (25% of expenditures).
While the government has announced substantial cutbacks to expenditures as part of its reform programmes, President Macron recently scaled back public spending reductions. Previously announced measures included a moderation of the indexation of retirement pensions and other social benefits, the continued reduction of subsidised employment contracts, a reduction in the number of public sector employees and the continued control of healthcare spending.
Scope acknowledges the government’s efforts towards medium-term consolidation remaining unchanged with a clear view to moderate public spending, as evidenced in France’s structural and primary fiscal balances improving slowly through 2018. Going forward, Scope expects fiscal consolidation to be mainly driven by higher growth and continued low refinancing rates, with the structural deficit remaining roughly unchanged over the foreseeable horizon. Together with soft economic growth, Scope expects the 2019 budget deficit to increase to 3.2% of GDP, representing a non-negligible deviation from the previous official target of 2.8%. It is important, however, to note that fiscal balance projections include the one-off impacts of transforming the tax credit for competitiveness and employment (CICE) into permanent reductions in employer’s social security contributions, which Scope expects to account for 0.9% GDP. In addition, the gradual take-over of SNCF debt accounts for another 0.1% of GDP (according to the Maastricht definition). Accordingly, Scope projects fiscal slippage in 2019 to be temporary in nature, and thus expects the authorities to continue pursuing its medium-term consolidation strategy.
As a result, according to Scope’s baseline scenario, the current debt ratio of 98.4% is unlikely to decrease substantially over the forecast horizon. At the same time, Scope also acknowledges that higher potential growth and the low interest rate environment support a favourable growth-interest-rate differential, which will help stabilise the debt ratio at levels just under 100% of GDP in 2019.
Finally, Scope notes that a continuation of reforms including fiscal consolidation depends on the authorities’ ability to strike the right balance between structural reform, fiscal consolidation and retaining public support. The government however faces increasing social protests to its political agenda. Arguments of gilets jaunes protestors include among others a lack of support for vulnerable groups and the discrimination of regions with special needs such as the suburbs and the countryside. For now, the government has prioritised its reform programme alongside fiscal measures that support vulnerable low- and medium-income households – including in December 2018 (EUR 9bn) and April 2019 (EUR 5bn) – at the expense of more expeditious fiscal consolidation, excluding planned but not concluded compensation measures to lower the overall impact on public finances.
Sovereign rating scorecard (CVS) and Qualitative Scorecard (QS)
Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative ‘A’ (‘a’) rating range for the French Republic. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis.
For the French Republic, the following relative credit strengths are identified: i) growth potential of the economy; ii) economic policy framework; iii) macro-economic stability and sustainability; iv) market access and funding sources; v) current account vulnerability; vi) external debt sustainability; vii) vulnerability to short-term external shocks; viii) recent events and political decisions; ix) banking sector performance; x) banking sector oversight and governance; and xi) financial imbalances and financial fragility. No credit weaknesses relative to peers were identified.
The combined relative credit strengths and weaknesses signal a sovereign rating of AA for the French Republic.
A rating committee has discussed and confirmed these results.
Factoring of Environment, Social and Governance (ESG)
Scope considers ESG sustainability issues during the rating process as reflected in its sovereign methodology. Governance-related factors are explicitly captured in our assessment of ‘Institutional and Political Risk’, for which France achieves a high score according to the World Bank’s Worldwide Governance Indicators. Qualitative governance-related assessments in the ‘geo-political risk’ category of our Qualitative Scorecard, for example, are assessed as ‘neutral’ compared with France’s ‘a’-indicative sovereign peers. Socially related factors are captured in Scope’s Core Variable Scorecard in France’s high GDP per capita (EUR 36,292 in 2018), relatively low old-age dependency ratio but high level of structural unemployment. Qualitative assessments of social factors are reflected in the QS’ ‘macroeconomic stability and sustainability’ evaluation, for which Scope assesses France as ‘strong’ relative to peers. Finally, environmental factors are considered during the rating process but did not have an impact on this rating action.
Scope assesses qualitatively the extent of policy actions towards achieving the Paris accord on climate change. France hosts the largest green bond market in Europe and the third largest globally. In 2017, the French government launched the largest green bond to date, with a current outstanding volume of EUR 18.4bn (1.75%, maturing 25 June 2039). The government has continued to make progress since then with a more diversified issuance structure and new instruments. At the same time, President Macron has prioritised policies addressing climate change. The government recently submitted a legislative proposal committing France to carbon-neutrality by 2050. However, the government has not yet defined policies on how to reach this objective, leaving the door open for (at least temporary) energy provision substitution via nuclear power. Also, the planned introduction of higher fuel taxes was recently cancelled as a response to the gilets jaunes protests. France’s revenues from environmental taxes have steadily increased since 2009 reaching 2.3% of GDP in 2017, but still remain below the EU-28 average of 2.4%.
Outlook and rating-change drivers
The Stable Outlook reflects Scope’s expectation of a continuation of the government’s reform programme over the medium term but for public debt to remain high, albeit on a stable trajectory.
The ratings/outlooks could be upgraded if: i) the process of structural reforms continues; and/or ii) there is sustained fiscal consolidation.
The ratings/outlooks could be downgraded if: i) there is a rollback of structural reforms; and/or ii) fiscal policies raise questions around debt sustainability.
The main points discussed by the rating committee were: i) France’s growth potential outlook ii) the government’s structural reforms, iii) fiscal policy developments, iv) debt sustainability, v) latest political developments vi) peer considerations.
The methodology used for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on www.scoperatings.com.
Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies at www.scoperatings.com.
The rating outlook indicates the most likely direction in which a rating may change within the next 12 to 18 months.
Solicitation, key sources and quality of information
The rating was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.
The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: the Ministry of Finance of the French Republic, the Banque de France, the Debt Management Office (AFT), the National Statistical Office (INSEE), the BIS, the European Commission, the European Central Bank (ECB), the Statistical Office of the European Communities (Eurostat), the IMF, the OECD, and Haver Analytics.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the rating, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst: Dr Bernhard Bartels, Associate Director
Person responsible for approval of the ratings: Dr Giacomo Barisone, Managing Director, Public Finance
The ratings/outlook were first assigned by Scope in January 2003. The ratings/outlooks were last updated on 30.06.2017
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.
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