France: Credit-Rating Downgraded but Impact Uncertain

Moody, in a widely expected decision, downgraded France’s credit-rating from Triple A to AA1 on November 19. The ratings agency said it took this decision because “France’s long-term economic growth outlook is negatively affected by multiple structural challenges, including its gradual, sustained loss of competitiveness and the long-standing rigidities of its labor, goods and the service markets.” The challenges identified include France’s lack of competitiveness, high unemployment, public debt and market rigidity. In simpler terms, these are high taxes and social contributions, strong employment protection legislation, and low levels of innovation. As an aside and, in defense of the French, it’s tough to increase levels of innovation while reducing taxes since most innovation comes from either government funding or subsidy support.

Moody’s downgrade a similar decision by Standard and Poor’s (S&P) in January and Paris’ reaction has been both bad – blaming the preceding Sarkozy administration – and good – announcing $26 billion of tax breaks for companies. Despite this positive step, intra-governmental conflicts will prevent the implementation of other pro-business policies; French Socialists – who have been in power since May – have spent most of their time raising taxes. On an optimistic note, the Socialists may face pressure from the European Union (EU) since economic issues for France inevitably will cause problems for Europe. Paris should listen to the EU because the French economy has trade and banking exposure to the troubled Euro-zone economies and is also affected by European Community decisions to support countries such as Greece and Spain.

Despite the negative connotations of this downgrade, its impact is unclear; only Germany, Finland, Luxembourg and the Netherlands retain a Triple A credit rating from all ratings agencies and the downgrade of the US rating hasn’t affected our ability to raise funds in the international market. In addition, Moody’s report mentioned some positives such as France’s diversified economy and Paris’ commitment to structural reform and fiscal consolidation. The agency also stated that they would consider changing the country’s outlook from negative to stable if Paris implemented economic reforms and tax measures that “effectively strengthen the growth prospects of the French economy and the government’s balance sheet” and reverse the “upward trajectory in public debt”. I do not believe Moody’s or S&P will reverse their decisions any time soon for a number of reasons including the intra-government conflicts noted above, Paris’ unrealistic GDP growth projections – the government anticipates GDP growth forecast of 0.8% in 2013 and 2% from 2014 – and the ongoing weakness of France’s export markets. Having said that, this downgrade is unlikely to hurt the country’s ability raise money in the open markets, which is all that matters at the end of the day.