Fitch Affirms France at ’AA’; Outlook Negative

KEY RATING DRIVERS

France’s ’AA’ ratings are underpinned by a large, wealthy and diversified economy, strong and effective institutions and a track record of macro-financial stability. Public finances, and in particular the high level of government debt, are a rating weakness. Low interest rates, a long average maturity of debt, and access to deep and liquid capital markets, both in France and abroad as a core eurozone member, partially mitigate the risks from high government debt.

The Negative Outlook reflects the shock to the French economy from the COVID-19 pandemic, which will leave public sector indebtedness substantially higher than in previous years. This deterioration will be in the context of already elevated debt levels compared with rating peers, limited progress in fiscal consolidation in recent years, and moderate economic growth. The pandemic will cause a sharp contraction in real GDP this year, and risks adversely affecting potential growth.

We expect the general government deficit to reach 10.5% of GDP in 2020, higher than our forecast at the time of the last review (9.3%). The deficit forecast for 2020 has been revised up due to higher than previously expected direct economic support measures to face the COVID-19 crisis worth around 3.8% of GDP, including 0.9% of GDP following the announcement of a four-week lockdown from end-October, and lower tax revenues resulting from a weaker macroeconomic backdrop. We forecast the deficit to narrow in 2021 and 2022, driven by the rebound in economic activity, to 7.3% next year, and 5.0% in 2022.

These projections are consistent with government debt/GDP reaching 117.6% this year and then peaking at 118.7% next year, at around three times the forecast ’AA’ median (46.7%). This would leave the debt ratio around 21pp higher than in 2019. We expect the debt ratio to edge down from 2022 onwards; our five-year baseline assumptions for public debt dynamics assumes that the debt ratio will be 117% by 2024.

Despite the persistently higher debt ratio, we expect interest payments as a share of government revenues to fall below 2.0% by 2022, an historical low (and below the ’AA’ median of 2.2%). This reflects the current low interest rates (the yield at issuance of government bonds up to October this year was -0.12%), likely continued supportive market conditions underpinned by ECB policy, and a long average maturity of debt (around eight years), which provides some offset in the event of interest rate rises.

Containment measures to address the spread of the pandemic brought about a sharp reduction in economic activity in 2Q. There was a fast rebound in GDP in the third quarter, but with restrictions introduced for the recently announced four-week lockdown to be phased out only gradually, they will negatively affect activity both in 4Q and the start of 2021. Overall, we expect real GDP to decline by 10.2% this year (revised downwards from the last review from -7.0%), and rebound by 4.5% next year and 3.1% in 2022. Our forecasts imply that the level of real GDP at the end of 2022 will still be around 2.5% lower than in 4Q19.

We expect the impact of the current crisis on unemployment to materialise next year, with a substantial increase in the unemployment rate to an annual average of 10.6%. Worsened labour market prospects and uncertainty affecting spending by firms and households may slow the pace of the recovery, leading to dampened growth potential.

Our public finance and growth projections do not yet incorporate the government’s Plan de Relance initiative, which aims to support the economic recovery over the years ahead through public spending, investment and supply side measures and guarantees. According to French government estimates, the recovery plan will add 1.5pp to growth from 2021. Around 40% of the financing is expected to be covered by EU recovery initiatives. The draft 2021 budget indicates that the public deficit could be around EUR20 billion (0.9% of Fitch forecast GDP) higher than would be otherwise.

The French banking sector scores ’a’ on Fitch’s banking system indicator. Banking sector metrics suggest that French banks have yet to see a substantial worsening in asset quality and solvency metrics due to the coronavirus crisis. European Banking Authority data show that in 2Q20, the overall capital ratio for French banks was 16.0%; the non-performing exposure ratio was 2.1%, compared with 2.4% a year earlier. Nevertheless, significantly higher loan impairment charges (up by 2.5 times yoy), which include provisioning for one-third of expected loan losses, and other factors linked to the economic and financial environment, cut the sector’s operating profitability by almost 50% yoy in 1H20.

As part of the government response to the pandemic, substantial schemes of loan guarantees have been set up this year. The main one, worth up to EUR300 billion (around 13.5% of forecast 2020 GDP) covers new loans granted to French firms between mid-March and end-June 2021 (the take-up of these guarantees up to mid-October was EUR120 billion). The state guarantee covers 90% of loans to small firms, and 70%-80% of the loan for larger firms. Fitch assumes that only a small proportion of this will crystallise on the government balance sheet.

We expect the current account deficit to deteriorate this year, from 0.7% of GDP to 2.0% of GDP, on the back of weak exports of both goods and services, before easing to 1.5% by 2022. Net external debt is expected to rise to 48.8% of GDP, from 42.1% at end-2019 (’AA’ median forecast for 2020: -5.7%). We do not currently assess that the rise in net external debt is an indicator of a substantial increase in external vulnerability.

ESG - Governance: France has an ESG Relevance Score (RS) of 5 for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. France has a high WBGI ranking at 84.2, reflecting its long track record of well-established rights for participation in the political process, strong institutional and regulatory capacity, effective rule of law and a low level of corruption.