France downgraded; should it care?
Moody's thinks France has too many regulations.
Moody's, the credit rating agency, has downgraded French sovereign debt, from an Aaa rating to Aa1. The company also says that the outlook for French debt remains negative.
- 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 labour, goods and service markets.
- France's fiscal outlook is uncertain as a result of its deteriorating economic prospects, both in the short term due to subdued domestic and external demand, and in the longer term due to the structural rigidities noted above.
- The predictability of France's resilience to future euro area shocks is diminishing in view of the rising risks to economic growth, fiscal performance and cost of funding. France's exposure to peripheral Europe through its trade linkages and its banking system is disproportionately large, and its contingent obligations to support other euro area members have been increasing. Moreover, unlike other non-euro area sovereigns that carry similarly high ratings, France does not have access to a national central bank for the financing of its debt in the event of a market disruption.
In other words: the French economy is too regulation-bound, the French budget is too heavy on the deficit, and if the Euro goes down, France is going with it. The negative outlook – which signals the fact that Moody's expects a further downgrade in the next year to 18 months – is a reflection of the fact that none of these problems look likely to be temporary.
Of course, part of the reason why these problems look so long-lasting is because they have been true for quite some time. France hasn't balanced a budget in around 40 years, and even Moody's describes the "rigidness of its labour, goods and service markets" as "long-standing". As a result, the question raised in France has been "why now"?
Many believe the triggering factor is François Hollande's government's attempt to balance the budget on the backs of the rich, replacing many of the spending cuts and attacks on employee rights seen here with tax hikes and targeted investment. Hollande's finance minister, however, described the downgrade as a "sanction on the past", blaming Nicolas Sarkozy's government for failing to take action when it could.
The news serves only to underline a recent Economist cover story branding France the time-bomb at the heart of Europe. In it, the magazine wrote:
Our most recent special report on a big European country (in June 2011) focused on Italy’s failure to reform under Silvio Berlusconi; by the end of the year he was out—and change had begun. So far investors have been indulgent of France; indeed, long-term interest rates have fallen a bit. But sooner or later the centime will drop. You cannot defy economics for long.
Whether Moody's downgrade does represent a watershed moment for the image of France as one of the strong core nations of Europe, it will be hard to shrug off for the already beleaguered Hollande.
Of course, at this point it is worth remembering that the standard disclaimers about credit rating agencies: they aren't very good at rating credit, know less than any competent macroeconomist about sovereign debt, and basically just don't know what they're talking about. So France needn't be too scared just yet.
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