OREANDA-NEWS. December 16, 2015. 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'. 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, strong and effective civil and social institutions with a high general government debt/GDP ratio and fiscal deficit.

Persistent fiscal deficits spurred by high government spending have resulted in general government debt reaching 95.6% of GDP at end-2014, relative to a 'AA' category median of 35.9%. This high level of indebtedness limits France's ability to deal with fiscal shocks and constitutes the main weakness to France's sovereign rating.

According to Fitch's estimates, France's general government deficit will narrow to 3.4% of GDP in 2016 and 2.8% in 2017 from 3.8% this year, in line with the European Commission (EC) recommendation for France to correct its excessive fiscal deficit by 2017. The initial deadline was 2012 when the EC opened the Excessive Deficit Procedure in April 2009. Risks to the forecasts in 2016 and 2017 are tilted downward, with planned annual expenditure growth slowing to 0.4% in real terms, compared with average growth of over 1.2% in 2010-14. General government debt is expected to peak at close to 97% of GDP in 2017.

The 2016 draft budget presents a moderate expenditure based consolidation effort involving a 1.8pp decline in the expenditure-to-GDP ratio from 57.5% in 2014 to 55.7% by the end of the programme period (2015-2017). With EUR50bn of planned spending savings (relative to a rising baseline) just offsetting the EUR46bn cumulative cost of newly introduced tax cuts and credits for the programme period, the government is depending on the expected cyclical recovery and better fiscal starting point in 2014 (deficit of 3.9% of GDP compared with 4.4% in the 2015 budget) to meet its fiscal targets.

In Fitch's opinion, while meeting headline targets under baseline assumptions would be sufficient to reverse the debt trajectory starting in 2017, failing to make structural adjustments would represent a missed opportunity to benefit from the cyclical upturn by building a fiscal buffer, leaving public finances exposed to shocks, including lower than expected growth and/or inflation.

In its November published opinion on the 2016 budget, the EC reiterated that while it expects France to meet headline deficit targets for 2015 and 2016, it expects it to fall short of the targets for reducing the structural deficit and bottom-up fiscal adjustment effort for both years. For 2017, the EC expects France to miss both the headline and structural targets based on estimates that exclude unspecified measures under its usual no policy change assumption.

France's economic recovery is proceeding with growth this year supported by low oil prices and favourable monetary and tax policies boosting private consumption; and the euro depreciation bolstering exports. As the lift from these temporary factors fades in 2016-2017, domestic demand should see increased support from investment as company profit margins recover. Fitch expects GDP growth to pick up to 1.5% in 2016 and 2017 from 1.1% this year; and for inflation to rise from 0.1% this year to 1.3% by 2017. Unemployment will remain elevated at 10.5% this year, only easing to just below 10% by 2017.

While it is too early to assess the full economic impact of the 13 November terror attacks, Fitch expects a short-lived and limited slowdown in growth. In the immediate aftermath, a disruption to tourist activity and restaurant trade may depress private consumption and service exports as well as trigger some substitution in holiday season spending to internet shopping from in-store sales.

Uncertainty remains over France's long-term economic growth potential. The government has made important strides in its structural reform agenda, which focuses on goods and services and labour market de-regulation to restore competitiveness, and government re-organisation to promote savings.

Measures to be presented to parliament in 2016 include a new labour market act and second component of the 'Macron' law which focuses on de-regulation and includes a digital economy element. The quantitative impact of the reforms remains uncertain, and while the reform program does cover a wide range of industries, in Fitch's view, the measures do not appear to be deep enough to reverse the adverse trends in long-term growth. Our assumption for medium-term potential growth remains 1.5%, consistent with the EC estimate at 1.6% in its April 2015 Ageing Report.

Financing risk is low, reflecting an average debt maturity of seven years, low borrowing costs and strong financing flexibility. Government debt is entirely euro-denominated. There is low risk from contingent liabilities.

France has run moderate current account deficits, which have averaged less than 1% of GDP for the ten years to 2014. In 2015, France is projected to record its first non-deficit position since 2006, partly due to the favourable exchange rate environment. Net external debt, at 34% of GDP in 2014, compares with a creditor position of around 30% of GDP for the 'AA' peer group.

RATING SENSITIVITIES
The Outlook is Stable, which means Fitch does not expect developments with a high likelihood of leading to a rating change. However, 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 0.2% of GDP over the next 10 years, trend real GDP growth averaging 1.5%, 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 2017, before declining to 87% by 2024.

The European Central Bank's asset purchase programme should help underpin inflation expectations, and supports our base case that in the context of an economic recovery, France and the eurozone will avoid prolonged deflation. Nevertheless, deflation risks could re-intensify in case of adverse shocks increasing the real debt burden in the public and private sectors.

Fitch does not expect the December regional and 2017 presidential elections to derail reform or fiscal plans for 2016-17.