Moody’s downgraded the rating of the French public debt by one notch from Aaa to Aa1, following a similar move by Standards & Poor’s on 13 January 2012. The outlook was negative, leaving open the possibility of a further downgrade in the coming months. Only Germany, Finland, Luxembourg and the Netherlands currently keep their AAA rating in the Euro Zone. The EFSF’s rating could be affected in the following days as France is one of the major countries backing the European stabilization mechanism. The rating agency mentioned several factors explaining the downgrade.
- France’s long-term economic outlook is gloomy due to low competitiveness and rigidities on the job, service and goods markets.
- France’s fiscal outlook remains uncertain due to the current deterioration of the macroeconomic context, characterized by low external and domestic demand. The growth hypothesis of the French government, underlying its fiscal consolidation plan, was judged as overly optimistic, betting on 0.8% YoY in 2013 and 2% YoY in 2014.
- The resilience to future shocks remains problematic as the exposure to periphery’s countries, via trade and banking relations, is elevated. The size of the banking sector was judged by Moody’s as “disproportionally” large. Moody’s explained that France’s exposure to the periphery’s troubles was important due to contingent obligations linked to the EFSM-ESM, the European stabilization mechanism.
Moody’s main arguments are well-founded as France suffers from a structural lack of competitiveness due to high labor costs and persisting rigidities. These long-term difficulties have been accentuated in the short-term by a sharp slowdown of external and domestic demands, triggered by the simultaneous implementation of austerity plans across Europe.
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However, the deficit’s target, established at 0.3% of GDP by 2017, compared with 5.2% of GDP in 2011, 7.1% of GDP in 2010 and 7.5% of GDP in 2009, remains in our view achievable. The seriousness of the two main political parties in pursuing the fiscal consolidation, a level of unemployment rate remaining under control (10.8% compared with a Euro zone average of 11.6%), a potential reserve of untapped growth linked to a low level of households’ debt, and lower exposure to international negative shocks should pave the way to a progressive and slow decline of public debt.
Indeed, due to a strong social protection, France usually performs better than the average of European countries in difficult times, as reflected by the 0.2% QoQ growth in 3Q12 compared with -0.1% QoQ for the Euro Zone as a whole. This macroeconomic stability, a rapid and sound adjustment of banks (reducing the size of their assets and their exposure to short-term funding), the consistency of the government in tackling the issue of public debt, the existence of a European stabilization framework, and the reactivity of the ECB, will keep the pressure of the market on French public debt at a low level despite Moody’s decision. Finally, France is not a currency issuer, and cannot print Euros, it therefore has limited flexibility if bond vigillentes ‘went after French debt.’
The main question is not why, but what took so long for the downgrade to occur?