IS FRANCE being edged towards the door of Europe’s premier club? That’s the question that must have circulated in the corridors of power in Paris yesterday morning when the credit ratings agency Moody’s released its regular weekly report.
With France in the line of fire of the euro zone debt crisis, Moody’s warned that the outlook on its top-notch credit rating could soon be under threat.
Within hours, the French finance ministry responded with a statement talking up its position, but few are in any doubt that Paris now has a big fight on its hands to avoid a dreaded downgrade.
Just six euro zone countries – Austria, Finland, France, Germany, the Netherlands and Luxembourg – have triple-A ratings, the top category of credit-worthiness. The tag reassures investors these countries are extremely likely to meet their financial commitments, which allows them to borrow cheaply on international markets and, in the current maelstrom, sets them apart as havens of relative calm.
Over recent months, however, the markets have grown anxious about France.
In normal times, when its economy was growing steadily and its neighbourhood looked stable, investors were happy to overlook France’s huge debts and consistently high budget deficits (no French government has balanced a budget since 1974).
But the single currency’s debt crisis, revealing the once unimaginable prospect that a euro zone country could default, has led risk-averse investors to scrutinise the books more carefully. France remains one of Europe’s strongest economies. It has always been relatively immune to the boom-and-bust cycles that afflicted many European states, and was one of the first to pull out of recession in 2009. But some of its vital statistics make it the most vulnerable of the triple-A club.
Its budget deficit stands at 5.7 per cent of gross domestic product – almost twice the EU limit. Public debt is at €1.7 trillion. And, crucially, its fate is closely bound up with that of Italy and Spain – the markets’ latest targets – due to its banks’ habit of lending heavily in both states. As of June, French banks had an overall exposure to Italy of a massive €307.4 billion – the largest of any country.
All of this, allied to sluggish French growth, has been pushing up the spread, or difference, between the interest rate France pays to borrow money and the rate paid by Germany, which is seen as Europe’s safest place for cash. There’s a vicious circle here. Moody’s says it may change its outlook on France from “stable” to “negative” because of a weak economy and its rising cost of borrowing. And within hours of the agency’s report yesterday, the spread on French 10-year debt was up a further 20 basis points at 163.
As the German economist Jürgen Stark said in Dublin yesterday, the debt crisis has spread from the periphery to the core. France is the proof.
Financially and politically, the consequences are heavy. First, the numbers. Last week, France was paying nearly twice as much as Germany for long-term funding. Every additional 100 basis points on its interest rate roughly equates to an extra €3 billion in yearly funding costs. Even in an economy as large as France’s, that’s enough to knock its budget plans badly off course.
The French government protests that it is taking decisive action to staunch the fire in the markets and avert a downgrade. Earlier this month, it unveiled its second austerity package in three months, promising to save a further €7 billion next year to keep it on track to balance the budget by 2016.
President Nicolas Sarkozy’s problem is that many influential people don’t think his government is doing enough. France’s plans assume its economy will grow by 1 per cent next year, but the European Commission thinks that’s too optimistic and that further savings will be inevitable.
The suspicion among critics is that Sarkozy has held back the most painful cuts because he faces an election campaign next spring.
The political damage France would incur from a downgrade would be huge. To exit the triple-A camp would be a major symbolic setback for the continent’s second-biggest economy and the western partner in the Franco-German duo at the heart of European integration. It would reinforce the supremacy Berlin’s economic power gives it over Paris and make it even harder for Sarkozy to impose his will within the euro zone.
Domestically, it could also come at a high price. Sarkozy’s poll ratings have recently shown the first signs of recovery after two years at record lows. Next spring’s election promises to be close. But the president has explicitly made retaining the triple-A rating one of the planks of his term.
Losing it would leave him with a desperate fight to avoid becoming the latest European leader to be finished off by the markets.