OREANDA-NEWS. February 09, 2015. The adoption of a law cutting the number of French regional governments clarifies how their debt will be treated but changes to the regions' budgetary frameworks remain under discussion. This will be a key driver of the credit impact of current reforms, Fitch Ratings says.

French local and regional governments (LRGs) are experiencing their widest-reaching overhaul in more than three decades. On 27 January the French Senate adopted, at the first reading, the law on the Nouvelle Organisation Territoriale de la Republique (NOTRe). This will see the number of French regions reduced to 13 from 22 from 1 January 2016, via mergers of some neighbouring regions. The reforms aim to give the new larger regions a bigger role in economic development compared with other French local and regional governments (departments and municipalities).

Article 37 of the law specifies that the merged regions will fully assume all the debt obligations of their constituent regions. With the agreement of all parties, some adjustments are possible. However, we think that in most cases debt will be serviced under existing terms until maturity.

This is in line with the supportive institutional and administrative framework for French subnationals, which makes debt servicing a compulsory spending priority and is a credit strength.

Two Fitch-rated French regions are affected by the amalgamations. The region of Picardy will merge with the region of Nord-Pas-de-Calais, and the region of Midi-Pyrenees will merge with the region of Languedoc-Roussillon.

Although the law now provides clarity on how debt will be treated in the medium term, our full assessment of the mergers will depend on details of the wider reforms and their implications for the regions' budgetary profiles. The French Assembly will discuss the Decentralisation Act III through this year, and full implementation may be slow. It is possible that the planned mergers will not be complete by next year.

Larger regions may achieve economies of scale and improved bargaining power with suppliers but this may take time. In the short-term new regional governments may choose to maintain or increase spending in areas such as employee compensation and benefits for political reasons.

It is not clear how far revenue flexibility might be increased, for example by giving the regions more powers over taxation. Operating revenues are mainly based on non-modifiable taxes and transfers. These have been under pressure due to sluggish growth (we forecast real GDP growth of 0.8% in France this year) and a sharp drop in state grants as the central government attempts to balance France's public finances. Transfers to LRGs will fall by 20% in 2015-2017, although most of the decline will be felt by municipalities and departments.

Declining operating revenue driven by state transfer cuts, and the consequent weakening of its financial profile, was one reason we downgraded Picardy to 'A+' from 'AA-' in December 2014. In the same month, we downgraded the Midi-Pyrenees to 'AA' from 'AA+', in line with the action taken on the French sovereign. We expect Midi-Pyrenees' operating margin to decline in 2015-2017, but it will remain considerably higher than that of Picardy. The Outlook on both ratings is Stable.

Contact:

Christophe Parisot
Managing Director
International Public Finance
+33 1 44 29 91 34
Fitch France S.A.S.
60 rue du Monceau
75008 Paris

Arnaud Dura
Associate Director
International Public Finance
+33 1 44 29 91 79

Mark Brown
Senior Director
Fitch Wire
+44 203 530 1588

Media Relations: Francoise Alos, Paris, Tel: +33 1 44 29 91 22, Email: francoise.alos@fitchratings.com; Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.