France avoided a rating downgrade from Moody’s, but the rating agency painted a bleak picture of the euro zone’s second-largest economy, highlighting risks linked to its intractable policies.
In a statement released Friday evening, Moody’s kept France at Aa3 – two ratings below the United States and three below Germany – with a negative outlook, while the ratings of peers Fitch and S&P Global are one notch lower.
France still has a rich economy and competent public institutions, according to Moody’s, but the political landscape threatens to paralyze the government and prevent it from taking painful deficit reduction measures.
The report highlights the division of the French Parliament, often at odds with the government, as well as political and social instability. For more than a month, the country has been gripped by demonstrations which degenerated into widespread riots last weekend.
At first, students decried the lack of investment in public education, then others joined in denouncing the high cost of living as fuel prices skyrocket due to the U.S. war against Iran. Other European countries saw similar protests in what was dubbed the “October 17 Movement.”
At the same time, France’s looming debt has sent bond yields to their highest levels in 24 years, signaling warning signs not seen since the eurozone debt crisis in 2011. France’s public debt now stands at a record $4 trillion, or 119% of GDP – the highest ratio since the immediate aftermath of World War II.
With far-right and far-left candidates leading the charge to become France’s next president this spring, markets are losing confidence in both camps’ ability to take the tough steps needed to restore fiscal order.
A 2027 budget proposal that would modestly reduce the deficit to 5% of GDP from 5.4% is now on the table but has not yet been adopted amid political impasse, and Moody’s has warned that recent unrest could limit fiscal consolidation efforts.
“The 2027 budget process coincides with some of the most significant social protests France has seen in many years,” he said.
Moody’s expects the budget to eventually be passed, but perhaps by decree, as the National Assembly procrastinates. Even then, the budget is likely to be less effective than expected, reducing the deficit to 5.2% of GDP due to lower GDP growth than the government forecast and policy challenges in implementing real spending cuts.
This budget, too little, too late, will not put an end to France’s debt problems. Moody’s said a “significant and sustained fiscal effort” was needed beyond the presidential elections to stabilize the debt burden, which is on track to reach 122% next year. The rating agency is not convinced that French leaders will be up to the challenge.
“While we expect the next president and government to seek to continue reducing France’s deficit, our basic assumption is that they are unlikely to be able to implement rapid fiscal consolidation in light of social tensions, a political environment that is likely to remain fragmented, and moderate GDP growth,” he predicts. “As a result, the debt burden will continue to increase until the end of the decade. »
There is still time since Moody’s points out that the average maturity of French debt is around 8.5 years. This means that the recent surge in borrowing costs must be sustained over an extended period to make debt significantly more affordable.
But France is particularly vulnerable to “event risks” linked to geopolitics as well as domestic politics and instability, Moody’s added, describing a situation in which lawmakers will struggle to tackle the most pressing issues.
“This negative outlook reflects the increased risk that the fragmentation of the French political landscape will continue to undermine the functioning of the country’s legislative institutions,” the report said.
“This political instability, also visible in current social tensions, risks hampering the French government’s ability to address key policy challenges such as a high budget deficit, a growing debt burden and a sustained increase in borrowing costs, thus leading to a weakening of key sovereign credit indicators faster than expected.”
Thierry Wizman and Gareth Berry, global strategists at Macquarie, have also linked the French debt crisis to the protests.
In a note released earlier this month, they warned that the longer the protest continued, the more likely it was that the government would give in and approve more spending, making the debt situation worse.
That would drive up French bond yields, making borrowing to finance such spending even more expensive – and thus worsen the problem the rioters are complaining about.
“France is moving towards a real civil crisis due to its political polarization, which until now manifested itself mainly in the political domain itself and only at the ballot box,” they write. “And rather than these being isolated events, we believe that a direct and self-reinforcing causal link can be established between the rise in French debt yields and the street riots of recent days.”
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