DBRS Morningstar Confirms Republic of France at AA (high), Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of France’s Long-Term Foreign and Local Currency – Issuer Ratings at AA (high). At the same time, DBRS Morningstar confirmed the Republic of France’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trends on all ratings remain Stable.

KEY CREDIT RATING CONSIDERATIONS
The Stable trend reflects DBRS Morningstar’s view that despite the challenges that stretch France’s public sector balance sheet, the government remains committed to gradually improving its medium-term fiscal performance. The energy price shock that began roughly two years ago and the ensuing rapid rise in interest rates slowed down the economy’s strong post-pandemic recovery. Thanks to government measures, inflation in France at its peak was more contained compared to EU peers, but the decline in inflation has been gradual. While GDP growth in France is set to decelerate in 2023, the economy is still expected to outperform the Euro area average. For France’s public finances, the government faces social and political obstacles to reduce its high public expenditure ratio, complicating a more rapid fiscal repair. Despite this, the government appears committed to reducing in structural terms its large fiscal deficit and its public debt ratio.

France’s AA (high) ratings are underpinned by the country’s wealthy and diversified economy, sound public institutions, and strong public funding profile. France is a core member of the euro area and has a sound banking sector. The economy is resilient during crises due in part to strong social protections. However, this benefit results in structurally high public expenditures that are difficult to reduce and that delay the rebalancing of fiscal accounts. Policy predictability decreased following the legislative elections in June 2022 when the governing alliance lost its majority in the National Assembly. Since then, President Macron’s weaker position in parliament and political fragmentation undermine public support for the government’s ambitious reform agenda and its intention to slow the pace of expenditure growth and repair public accounts – key for the country to maintain its very strong credit profile.

CREDIT RATING DRIVERS
The ratings could be upgraded if fiscal consolidation is faster and more durable than currently expected; or if policy measures and reforms significantly improve the productive capacity of the economy. The ratings could be downgraded if the government takes significantly longer than is currently expected to repair the medium-term fiscal outlook; or if the deterioration in the political environment materially weakens the government’s ability to address economic challenges.

CREDIT RATING RATIONALE
France’s Economic Growth Performance Decelerates In 2023

Russia’s invasion of Ukraine last year and the subsequent energy price and interest rate shocks slowed the growth rate of the French economy to 2.5% in 2022, following the strong post-pandemic rebound of 6.4% growth in 2021. Economic performance has slowed this year, although by less than previously expected. Real GDP growth surprised to the upside in the second quarter of 2023 to expand by 0.5% q-o-q due to a strong contribution from net exports. Despite persistent inflationary pressures and higher interest rates, private investment has proven resilient, while private consumption remains hampered by higher prices and declining purchasing power. The harmonised consumer price index (HCPI) in France averaged 5.9% in 2022. This was the lowest in the EU thanks to ample government support measures, including regulated electricity and gas prices, and fuel rebates. The gradual lifting of regulated prices and the passthrough from higher food and services prices have prevented price growth from declining more rapidly. HCPI was 5.9% in July 2023 y-o-y and the European Commission (EC) expects inflation to average 5.6% this year before declining to 2.7% in 2024.

Activity is likely to improve in the coming years as price pressure dissipates and real disposable incomes recover. These forces should correspondingly reduce uncertainty and the still elevated savings rate. The stabilization of interest rates is also likely to improve the outlook for investment. The EC forecasts the French economy to expand by 1.0 % in 2023 and to reach its 1.2% growth potential in 2024. Improvement in the output potential of the French economy is contingent on successful execution of the government’s ongoing and ambitious reform agenda. Following the difficult passage of pension reform earlier this year, the government plans to press ahead with additional structural changes to the labour market, to education and training, and to the green energy transition.

Large Fiscal Support To Protect The Economy And High Structural Spending Weigh On Public Accounts

The reoccurring economic shocks since 2020 and the government’s exceptional support measures to protect businesses and households have forced a significant deterioration of the fiscal balance. The fiscal deficit reached 8.9% of GDP in 2020 and improved to 6.5% in 2021 as the economy began to recover. Spending has been directed to support health outcomes, mitigate the economic fallout from the pandemic, and finance the recovery. France Relance (EUR 100 billion or roughly 4% of GDP) and France 2030 (EUR 54 billion) are plans meant to encourage the digital and ecological transitions and bolster the competitiveness of corporates and the labour force. Spending from the France Relance plan is expected to be completed by the end of this year, and as of the end of April 2023, the government had committed EUR 18 billion of the total France 2030 envelope.

The government has also mobilized large sums of money to lessen the bite to consumers and producers from high energy prices, including a cap on gas and electricity prices. All measures to offset rising prices from October 2021 through end-2023 are expected to amount to a net cost of around EUR 65 billion or roughly 2.2% of GDP. This is in part why the deficit remained high at 4.7% of GDP in 2022, despite strong revenue growth and unwinding pandemic-related spending. The public balance is also stressed by high structural public spending, one-third of which is indexed to inflation. The public expenditure-to-GDP ratio was 57.5% in 2022, the highest in the EU. Additional spending demands, a weaker than expected economic performance, or both, would challenge the government’s 4.9% of GDP deficit target for 2023. Even including cost-saving benefits from pension reform, the government does not expect the deficit to fall below the 3.0% of GDP threshold until 2027. This is among the slowest fiscal consolidations in Europe.

Government Debt Expected To Stabilize At High Levels; Strong Public Debt Profile

The various shocks in recent years have resulted in a large increase in France’s public debt burden. The debt-to-GDP ratio increased from 97.4% in 2019 to 115.0% in 2020, and then declined to 111.8% in 2022. The 2023 Stability Programme expects stabilization of the ratio around 110% over the next few years and then gradually declining to 108% by 2027. The country’s high debt ratio remains a vulnerability for France as it exposes the country to increases in interest rates. Debt servicing costs are expected to increase from 1.2% of GDP in 2020 to 1.9% by 2025, according to the IMF. However, France continues to have a strong funding profile. The government took advantage of favourable financing conditions in recent years to extend average maturities to 8.5 years, ensuring a gradual passthrough from higher rates to higher funding costs. These features support DBRS Morningstar’s positive qualitative adjustment for the “Debt Management and Liquidity” building block.

The French Banking Sector’s Strong Recent Performance, Pandemic And Energy Crises Notwithstanding

Pressure has started to build up on bank balance sheets as insolvencies stem from the inflationary shock, the slowdown in economic activity, and the pull back of government support. Likewise, French bank shares were not entirely immune to the stress from global financial markets that ensued following global bank stress earlier this year. But French banks confront the many challenges well capitalised, and with strong liquidity positions and asset quality. The ratio of Tier 1 capital to risk-weighted assets was 14.9% in 2022, and the ratio of nonperforming loans to total loans was 2.4%. Corporates also appear resilient despite the difficult environment. The increase in corporate debt since 2020 has largely been offset by cash reserves, indicating only a slight increase in net debt since 2020. The build-up of household savings since the beginning of 2020 has also been significant. These factors support our positive adjustment to the “Monetary Policy and Financial Stability” building block assessment.

External Sector Risks Are Contained

France does not have material external imbalances. France’s current account deficit, which averaged 0.5% of GDP from 2015 to 2019, widened to 1.8% in 2020 as the pandemic affected tourism and service sector inflows and dampened the export performance of the aeronautics and automobile industries. The current account deficit was 1.7% in 2022 due to the increase in energy prices, and the IMF expects it to gradually narrow towards balance by 2027. The net international investment position (NIIP) improved to -23.8% of GDP in 2022, roughly back to the 2019 outcome. Furthermore, France has limited exposure to Russia as a trade partner, given that Russia represented about 1.0% of French exports and imports in 2020. France’s open economy with extensive trade, investment, and financial linkages throughout Europe and globally support the positive qualitative adjustment for the “Balance of Payments” building block.

The Government Passed Pension Reform Earlier This Year And Survived Censure Votes

President Macron of the “Renaissance” party was re-elected in April 2022 after defeating Marine le Pen of the “National Rally” by a narrower margin than in 2017. The strong performance of the far-left and far-right coalitions illustrates the growing polarisation in France. While the ruling coalition lost its absolute majority in the June 2022 legislative elections, the government recommitted to the reform agenda previously interrupted by a series of events, including the “gilets jaunes” protests, the pandemic, and the energy crisis.

After months of consultation and rolling protests, the government passed pension reform in March 2023 using a constitutional procedure to bypass a vote in the legislature. In the following days as social unrest intensified, the government survived two votes of no confidence – cementing the reform into law. DBRS Morningstar is of the view that the main pillars of the reform, including raising the retirement age to 64 and extending the minimum contribution years to 43, should improve employment outcomes by further encouraging labour participation. However, the reform was unwelcome by an important share of the French population and the manner by which it was enacted inflamed social tensions on many occasions during the first half of 2023. France is nevertheless a strong performer on governance indicators and this government remains committed to repairing medium-term fiscal accounts and to following through on its ambitious reform agenda.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental, Social, or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (4 July 2023) at https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-riskfactors-in-credit-ratings.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/420951.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in Euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (29 August 2022) https://www.dbrsmorningstar.com/research/401817/global-methodology-for-rating-sovereign-governments. In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-riskfactors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

The sources of information used for this rating include Ministry of Economy and Finance (Stability Programme 2023), National Institute of Statistics and Economic Studies (INSEE), Banque de France (Macroeconomic Projections, June 2023), Agence France Tresor, High Council on Public Finances, Eurostat, European Commission (European Economic Forecast Summer 2023); International Monetary Fund (World Economic Outlook, April 2023; Article IV Consultation, January 2023), World Bank, Bank for International Settlements (BIS), OECD, the Social Progress Imperative (2021 Social Progress Index), Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: YES
With Access to Management: Yes

DBRS Morningstar does not audit the information it receives in connection with the credit rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and credit ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.
The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/420950.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Co-Head of Global Sovereign Ratings
Initial Rating Date: May 12, 2011
Last Rating Date: March 24, 2023

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