OREANDA-NEWS. Fitch Ratings has affirmed France's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'AA' with Stable Outlooks. The issue ratings on France's unsecured foreign and local currency bonds have also been affirmed at 'AA'. At the same time, Fitch has affirmed the Short-term foreign currency IDR at 'F1+' and the Country Ceiling at 'AAA'.

KEY RATING DRIVERS
The affirmation and Stable Outlooks reflect the following factors:

France's ratings balance a wealthy and diversified economy, track record of relative macro-financial stability, moderate levels of household debt and strong and effective civil and social institutions with a high general government debt/GDP and fiscal deficit.

The budget deficit is high relative to peers and will decline only gradually. In March 2015 the European Council recommended to France that it correct the country's excessive fiscal deficit (defined as above 3% of GDP) by 2017. The initial deadline was 2012 when the Council opened the Excessive Deficit Procedure (EDP) in April 2009. It was first postponed by the Council to 2013 in December 2009, then to 2015 in June 2013.

The government's new deficit target of 2.7% by 2017 (revised from 2.9% in the 2015 budget) represents a moderate pace of fiscal consolidation, with the fiscal deficit better than expected at 4% of GDP in 2014 (compared with 4.4% in the 2015 budget) and recent better than expected economic performance. The government's fiscal effort, as measured by the change in the structural balance, is lower than the effort recommended by the European Council in March but with a realistic forecast for a headline deficit below 3% of GDP by 2017, Fitch does not expect this to trigger any further action by the EU on France under the EDP. Fitch previously expected the fiscal deficit to be slightly above 3% in 2017.

The economy has recently performed better than expected and the risks to the outlook are more balanced as euro weakness and lower oil prices provide some boost. Fitch has revised up near-term growth prospects for France on 1Q15 GDP data from INSEE, which showed the economy expanded by 0.6% from 4Q14 - the fastest pace since 2Q13. For 2015, the agency now expects GDP to expand by around 1.2% (revised up from 0.8% previously) and 1.5% in 2016 (up from 1.2% previously). Fitch does not expect the economic recovery will be strong enough to make a significant dent in France's high unemployment rate. We expect the labour market will remain a drag on the recovery. The jobless rate averaged around 10.3% in 2014 according to Eurostat and Fitch expects it to remain broadly unchanged this year.

The lower budget deficits and better growth performance in the near term means Fitch now expects the public debt to GDP ratio to peak at 97% of GDP in 2016 (previously 99.4% in 2017) after which it should be on a declining path. The ratio remains more than double the 'AA' median of 36%, limiting the fiscal scope to deal with shocks. Fitch expects government indebtedness to remain high in the medium term.

Uncertainty remains over France's long-term economic growth potential. The government has already started implementing a programme of structural reforms and stated its intention to continue on this path, including territorial reform and the 'Macron' law on growth, economic activity and equal opportunities. However, the quantitative impact of the reform programme is uncertain, and in Fitch's view does not appear sufficient to reverse the adverse trends in long-term growth and competitiveness. Although the 'Macron Law' is wide, it does not seem to us particularly deep. Fitch has maintained its long-term potential growth estimate at 1.5%.

Fitch judges financing risk to be low, reflecting an average debt maturity of seven years, low borrowing costs and strong financing flexibility. Government debt is entirely euro-denominated.

While the current account balance has generally been on a deteriorating trend for most of the past 20 years, partly due to France's loss of export market share, the deficit is moderate at 1% of GDP in 2014 and has stabilised more recently. Fitch projects the deficit to remain around this level. However, France's net external debt is significantly higher than most rating peers at 31% of GDP at the end of 2014

There is low risk from contingent liabilities. In recent years, the financial sector has been cleaning up its balance sheets, strengthening funding, liquidity, capital and leverage. The risks from the eurozone crisis management mechanism including the EFSF and ESM have also eased owing to the actions of the ECB and the on-going gradual economic recovery of the single currency area.

RATING SENSITIVITIES
The main factors that could lead to negative rating action, individually or collectively, are:
- Weaker public finances reducing confidence that public debt will be placed on a downward trajectory.
- Deterioration in competitiveness and weaker medium-term growth prospects.

Future developments that could individually or collectively, result in positive rating action include:
- Sustained lower budget deficits, leading to a track record of a decline in the public debt to GDP ratio from its peak.
- A stronger recovery of the French economy and greater confidence in medium-term growth prospects particularly if supported by the implementation of effective structural reforms.

KEY ASSUMPTIONS
In its debt sensitivity analysis, Fitch assumes a primary surplus averaging 0.7% of GDP over the next 10 years, trend real GDP growth averaging 1.6%, an average effective interest rate of 2.5% and GDP deflator of 1.5%. On the basis of these assumptions, the debt-to-GDP ratio would peak at 96.9% in 2016, before declining to 83.6% by 2023.

Fitch's base case is that Greece (CCC) will remain a member of the eurozone, though it recognises that 'Grexit' is a material risk. Although a Greek exit would represent a significant shock to the eurozone that could spark a bout of financial market volatility and dent confidence, Fitch does not believe it would precipitate a systemic crisis like that seen in 2012, or another country's rapid exit.