December 9, 2016 / 9:10 PM / 7 months ago

Fitch Affirms France at 'AA'; Outlook Stable

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(The following statement was released by the rating agency) LONDON, December 09 (Fitch) Fitch Ratings has affirmed France's Long-Term foreign and local currency Issuer Default Ratings (IDR) at 'AA' with Stable Outlooks. The issue ratings on France's unsecured foreign and local Long-Term and Short-Term currency bonds have also been affirmed at 'AA/F1+'. Fitch has affirmed the Short-Term foreign and local currency IDRs at 'F1+' and the Country Ceiling at 'AAA'. KEY RATING DRIVERS The affirmation and Stable Outlooks reflect the following factors: France's ratings balance a wealthy and diversified economy, track record of relative macro-financial stability, strong and effective civil and social institutions with a high general government debt/GDP ratio and fiscal deficit. France's rating is supported by its strong financing flexibility, as a core eurozone member with access to the eurozone's deep and liquid capital markets, and with government debt entirely denominated in euros. Persistent, although declining, budget deficits spurred by high government spending have resulted in general government debt (GGGD) that is projected by Fitch to peak at 98% of GDP in 2018, relative to a 'AA' category median level of less than 40%. High indebtedness limits France's ability to deal with fiscal or economic shocks and constitutes the main weakness to France's sovereign rating. A series of developments over the last 12 months has had a moderate negative impact on the already tepid growth outlook in France, including the UK's decision to leave the EU in June, and the series of terrorist attacks that have taken place since 2015. This has led to downward revisions to Fitch's GDP growth estimate to an average of 1.2% for 2016-2018, compared with 1.4% forecast for the same period in the previous review. In line with the growth drivers in 2016, the modest recovery in 2017 and 2018 will continue to be supported by domestic demand, underpinned by the gradual labour market recovery, while the boost to real disposable incomes from low energy prices will gradually diminish. The acceleration of investment that has taken place over the past few quarters will continue into 2018, aided by still improving profitability in the corporate sector, supportive fiscal measures, and ultra-loose monetary policy. Political risk has increased, in Fitch's view. The possibility of a Marine Le Pen victory in the upcoming presidential elections is not our base case, but in Fitch's judgement has increased and is non-negligible. The surge in populist and anti-establishment sentiment across the world, as seen in the vote for Brexit in the UK and election of Donald Trump in the US, and reflecting a host of grievances, including economic malaise and fears over security and immigration, increases the tail risk of a political shock to France, even though, according to polls, Le Pen's popularity has remained fairly stable in 2016. Current polls suggest that the two candidates in the second round will be Francois Fillon, of the centre-right (LR) party and Marine Le Pen of the National Front (FN) and that Fillon would comfortably win the run-off with roughly 65% of the vote. Nonetheless, Fitch recognises that political polls have a poor recent track record and that the elections are more than four months away so we do not discount the potential for other candidates to emerge. In the event of an LR victory, and based on Fillon's announced programme, likely policies would include a reduction in public expenditure, corporate and household tax relief measures, an increase in the VAT rate, abolishing the 35 hour work week, and raising the retirement age. As was the case for the Hollande administration, reform implementation would be challenged by strong political and social opposition in the context of frustrations with slow growth and high unemployment. In the event of a Le Pen victory, her party's protectionist, anti-EU and anti-immigration proposals would be unlikely to be implemented in full due to institutional constraints. With polls suggesting a centre-right majority in the legislative elections scheduled for June, a Le Pen presidency combined with a minority parliamentary position for the FN would lead to a 'cohabitation' scenario that could result in policy paralysis in a number of areas. A low probability but high impact event for France and Europe would be if Le Pen, having won the presidency, were able to overcome constitutional hurdles to follow through on her vow to hold a referendum on France's exit from the EU and the eurozone. Fitch assumes the 2016 budget deficit target of 3.3% of GDP will be met, driven largely by the government's political commitment to spending restraint. Additional expenses announced during this year relative to the budget were due mainly to one off measures (including financing the EUR1.5bn emergency employment plan), and have been offset, partly through management of expenditure appropriations. For 2017, a less ambitions draft budget relative to the 2016 Stability programme, a slower expected recovery, and the risk of slippage ahead of the elections, have led Fitch to revise up its deficit forecast to 3.2% of GDP, above the government's official target of 2.7%, and missing the European Commission (EC) deadline for France to reduce its 'excessive deficit' by 2017. With a EUR8.7bn reduction (0.4% of GDP) in planned expenditure savings in 2017, the new draft budget features a lower fiscal effort than was planned in the Stability Programme of April 2016. This is reflected in expenditure growth that is 1.5pp higher than was planned in April, to be offset by a 0.6% of GDP increase in revenues to arrive at the target of 2.7% by 2017. Part of the revenue increase has been identified, but the plan to also lower corporate taxes, combined with slower economic growth, make the target difficult to achieve, in Fitch's opinion. The budget bill also contains EUR14bn in additional expenses (0.6% of GDP) that are offset by new measures. However, some of the offsetting measures are temporary (delayed tax dispute judgements), and difficult to ascertain (fight against fraud). Fitch now projects general government debt to peak at 98% of GDP in 2018, a year later and about 1% of GDP higher than we projected in the previous review. The government has implemented structural reforms that have contributed to a reduction in labour and production costs, including through some steps towards market deregulation. The new labour law, enacted in August 2016, gives employers and employees more flexibility through various measures including firm level (versus union level) collective bargaining, guidelines for economic redundancies, and a reduction in professional sectors. Liberalising certain sectors (coach transport) and extending Sunday working hours in applicable cases have resulted in an observable boost to activity in those areas. France has run moderate current account deficits, which have averaged less than 1% of GDP for the 10 years to 2015. After having achieved an almost balanced position in 2015, the current account is projected by Fitch to record an average deficit of 0.7% of GDP for 2016-2018, reflecting the unwinding of favourable temporary factors, including low oil prices and euro depreciation. Net external debt is projected by Fitch at 34.2% of GDP by year end-2016, compared with a creditor position of over 40% of GDP for the 'AA' peer group. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns France a score equivalent to a rating of AA on the Long-Term FC IDR scale. Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The Outlook is Stable, which means Fitch does not expect developments with a high likelihood of leading to a rating change. However, the main factors that could lead to negative rating action, individually or collectively, are: - Weaker public finances reducing confidence that public debt will be placed on a downward trajectory. - Deterioration in competitiveness and weaker medium-term growth prospects. - An outcome of the presidential and legislative elections that adversely affects the coherence and credibility of economic policymaking, economic performance, public finances, or financing flexibility. Future developments that could individually or collectively, result in positive rating action include: - Sustained lower budget deficits, leading to a track record of a decline in the public debt to GDP ratio from its peak. - A stronger recovery of the French economy and greater confidence in medium-term growth prospects particularly if supported by the implementation of effective structural reforms. KEY ASSUMPTIONS Fitch's base case is for France to remain a core member of the EU and the eurozone. Our long-run debt sustainability calculations are based on assumptions of GDP growth averaging 1.4% for the 10 years from 2015, a GDP deflator of 1.4%, and an average balanced primary budget position for the same 10 years. Fitch expects the global economy to perform broadly in line with assumptions set in its Global Economic Outlook (November 2016), and in particular eurozone GDP growth of 1.6% for 2016, and 1.4% for 2017 and 2018. Contact: Primary Analyst Maria Malas-Mroueh Director +44 20 3530 1081 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Marina Stefani Associate Director +44 20 3530 1809 Committee Chairperson Tony Stringer Managing Director +44 20 3530 1219 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. 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