Overview

• Tighter financial conditions and still-high core inflation will restrain France's economic activity in 2023 and 2024.
• We expect France's budget deficit will decline to 3.8% of GDP in 2026, from about 5% in 2023, with general government debt remaining above 110% of GDP.
• These forecasts are subject to risks related to growth and the government's economic and budgetary policy implementation.
• We affirmed our unsolicited 'AA/A-1+' sovereign credit ratings on France. The outlook remains negative.

Rating Action

On June 2, 2023, S&P Global Ratings affirmed its unsolicited 'AA/A-1+' long- and short-term foreign and local currency sovereign credit ratings on France. The outlook remains negative.

Outlook

The negative outlook reflects our view of downside risks to our forecast for France's public finances amid its already elevated general government debt.

Downside scenario

We could lower our sovereign ratings on France within the next 18 months if general government debt as a share of GDP does not steadily decline over 2023-2025 or if general government interest expenditure increases above 5% of revenue. Several factors could affect these dynamics, including:

• A prolonged slowdown in economic performance, especially if it damages long-term productivity;
• Failure to implement budgetary consolidation, for example due to persistently high public spending.

Upside scenario

We could revise the outlook to stable if a solid trajectory of budgetary and debt consolidation materializes in 2023-2025 and beyond, coupled with robust economic growth.

Rationale

France's wealthy economy and strong institutions underpin its creditworthiness. The French economy, the world's seventh largest, is open and very diversified.

Authorities have recently revised their medium-term budgetary consolidation strategy. The government aims to reduce the budget deficit to 3.2% of GDP by 2026, against its previous target of 3.4% presented in its public finance programming bill at the end of last year. We have slightly revised downward our budget deficit forecast over 2023-2025 to 4.6% of GDP, from 4.9% previously, and we now expect the deficit in 2026 to be 3.8%. This is mainly due the government's revised budgetary consolidation strategy, including the planned gradual phasing out of energy support measures in view of lower hydrocarbon prices as well as the impact of the recently implemented pension and labor market reforms, which we view positively. For example, the pension reform is expected to result in an increase in the working population due to the increase in statutory retirement age to 64 years from 62. This, together with additional elements such as the lengthening of the contribution period, is planned to balance the pension system accounts by 2030.

The difference between the government's budget targets and our forecasts mainly stems from our expectation of:

• Weaker economic growth (1.2% on average in 2023-2026 versus 1.5% underlying the government's 2023 Stability Programme update); and
• A more gradual reduction in public expenditure to GDP, given France's relatively weak track record of budgetary consolidation over past decades.

Despite these changes, throughout 2023-2026 we project gross general government debt will remain above 110% of GDP with a persistent, albeit declining primary budget deficit. France has not operated a primary budget surplus since 2007.

We believe there are risks to the execution of official budgetary targets. These include the lack of an absolute majority in the French Parliament since mid-2022, which could complicate policy implementation, remaining uncertainties in global and European economies, and tighter funding conditions.

The tightening of the European Central Bank's (ECB) monetary policy has increased financing costs for households, businesses, and the government. At the same time, the pass through of market rates into the cost of total French central government debt will be gradual as its average maturity is long dated (above 8.5 years) and the average interest rate on outstanding debt remains relatively low, expected at less than 2% in 2023.

Institutional and economic profile: Tighter financial conditions will weigh on France's growth in 2023 and 2024

• France's GDP growth will average 0.8% in 2023-2024 before returning to potential and averaging 1.5% in 2025-2026.
• Inflation has become more broad-based and will decelerate gradually to 5.4% in 2023 and 2.1% in 2026.
• Political fragmentation adds to uncertainties regarding economic policy implementation.

We currently project France's economy will expand by just 0.8% on average in 2023-2024, from 2.5% in 2022, as the ECB's monetary tightening, inflationary pressures, and the economic slowdown in Europe weigh on growth. This will negatively affect consumption (more than half of French GDP) and investment. France's real GDP grew by 0.2% in first-quarter 2023 compared with fourth-quarter 2022. Foreign trade contributed positively to GDP growth (in particular tourism and manufacturing of cars and aircraft), while investment spending declined and private consumption stagnated.

In our projections, headline inflation will decelerate to 5.4% in 2023, from 5.9% in 2022, but we expect the decline in core inflation will be delayed as wage pressure increases and some residual costs of higher producer and energy prices are passed on. France's headline inflation was the lowest in the euro area in 2022, mainly thanks to government support measures. These included caps on gas and electricity price increases and fuel rebates, which helped reduce headline inflation more than 2 percentage points (pp) on average last year, according to the government. The rise in regulated electricity and gas prices and the end of the fuel rebate in first-quarter 2023 pushed headline inflation up. The government has announced the maintenance of a cap on electricity prices for the next two years and the removal of the cap on gas prices. Progressive tax cuts for households planned before the pandemic, such as local taxes on primary residences, should provide some support to purchasing power too.

According to our forecast, economic growth will pick up and average 1.5% in 2025-2026, on the back of the economic growth acceleration in Europe and public investment activity such as the government's France 2030 program, which aims to boost sectors like biotechnology and decarbonize industry.

We believe labor market developments will be key in determining the outlook for private consumption. Like in most of the euro area, the labor market in France remains particularly resilient despite the economic slowdown. The employment rate increased to a record 68.6% in first-quarter 2023, the highest since data collection started in 1975. According to Eurostat's monthly data, the unemployment rate was 7.0% between February and April 2023, the lowest level in monthly terms in almost 40 years (since April 1983), down from 8.2% in December 2019. We expect fading momentum in industrial production and construction caused by higher interest rates will lead to a temporary increase in the average annual unemployment rate to 7.9% in 2024, up from our forecast of 7.6% for 2023 (see "Economic Outlook Eurozone Q2 2023: Rate Rises Weigh On Return To Growth," published March 27, 2023, on RatingsDirect).

In our view, the labor market performance and the French economy overall will continue to benefit from reforms implemented over the past decade. Most recently, these include the reform that introduced countercyclical modulation of duration of unemployment benefits, effective since early 2023, aiming at aligning the benefits with the underlying economic situation, and the 2019 unemployment benefit reform, which fully took effect at year-end 2021, aiming at tightening compensation rules and limiting recourse to short-term contracts. Active labor market policies, reduced administrative barriers for businesses, and a gradual decrease in corporate taxes to 25.0% by 2022 from 33.3% in 2017 should also support productivity gains. Moreover, the recently adopted pension reform is expected to result in an increase in the working population due to the increase in statutory retirement age to 64 years from 62. This, together with additional elements such as the lengthening of the contribution period, is planned to balance the pension system by 2030.

Political fragmentation adds to uncertainties regarding the government's ability to implement policies that increase economic growth potential and address budgetary imbalances. Without an absolute parliamentary majority, the government is facing strong parliamentary and nonparliamentary opposition to reform proposals--as demonstrated by recent widespread protests and strikes against pension reform. The government passed the 2023 budget and pension reform using the article 49.3 procedure, which allows finance and social security bills to go ahead without a parliamentary vote. This led to a series of motions of no-confidence against the government, none of which came to fruition. On the other hand, the bill aimed at facilitating the construction of new nuclear reactors (May 2023) and the most recent reform of unemployment benefits (November 2022) were passed in Parliament thanks to the support of opposition parties.

Flexibility and performance profile: Slow budgetary consolidation, although the French government's favorable debt profile will contain interest expenditure

• French general government debt will remain elevated at more than 110% of GDP in 2026, with budget deficits narrowing only gradually.
• Government interest expenditure will remain below 5% of government revenue.
• France has posted trade deficits for about 20 years, highlighting competitive pressures, but it also maintains sizable services and income surpluses.

The budget deficit in 2022 reached 4.7% of GDP, 0.3 pp smaller than we expected, mainly due the windfall increases in government revenue from higher-than-expected inflation. We expect the budget deficit will widen to 5% of GDP in 2023, due to the economic slowdown and the government's budgetary support measures to cushion the impact of high energy prices and inflation on households and businesses. The government estimates that the net cost of these support measures will reach €30.9 billion (1.1% of GDP) this year, about €1 billion less than in 2022.

We project the budget deficit will gradually narrow over the medium term to 3.8% of GDP in 2026, with general government expenditure declining to 55.5% of GDP over the same period, from 58.2% in 2022 (currently, the highest in the EU and among the highest across all the rated sovereigns). We expect the government will phase-out its energy support measures by end-2024 and the budgetary position will benefit from recently implemented reforms. According to the 2023 Stability Programme update, the 2023 pension reform would result in a net return of €17 billion by 2027, equivalent to 0.6% of GDP (€8 billion in savings on expenditure net of compensation measures and €9 billion in additional revenue from the resulting increase in activity). In addition, implementation of the latest reform of unemployment benefits would save about €4 billion, or 0.1% of GDP per year from 2024.

The government plans to limit the growth in primary spending (excluding support and recovery measures) to an average of 0.6% per year in real terms during 2023-2027, which would be the lowest average rate of growth over a consecutive five-year period in decades. In this context and in order to implement the planned budgetary consolidation as well as to reallocate resources toward green investments, the government decided to cut each ministry's budget by 5%. More recently, to support its deficit reduction plan, the government announced an additional 1% in ministry budget freezes. The government has also put in place an annual spending review mechanism, aimed at improving the efficiency of spending across the general government level with respect to boosting economic growth.

The government's new strategy to bring the budget deficit below 3% of GDP in 2027 also rests on the planned improvement of the aggregate balance of local and regional governments (LRGs) to 0.5% in 2027 from 0.0% of GDP in 2022. We consider the time profile of this improvement to be backloaded to the outer years of the program horizon. At the same time, while we note that the LRG layer of government has never recorded a surplus at that level, a similar magnitude of improvement (0.5 pp) was achieved on several occasions, most recently between 2013 and 2016.

The difference between our budget forecast and the government's targets is mainly due to our projection of weaker economic growth and a more gradual reduction in public expenditure to GDP, given France's relatively weak track record of budgetary consolidation over the past decades.

We currently project France's general government debt will remain above 110% of GDP in 2026, which is more than 10 pp higher than our forecast for the U.K. (unsolicited AA/Stable/A-1+), for example. The tightening of the ECB's monetary policy has increased financing costs for the government and we project general government interest payments will increase to 4.1% of general government revenue in 2026, from 3.3% in 2023. Nevertheless, because the average maturity of French central government debt is long dated (above 8.5 years) and the average interest rate on outstanding debt is low (below 2%), a pass through of market rates into the cost of total debt will be gradual. The average interest rate on outstanding debt will decline in 2023, before increasing again from 2024, because of the expected fall in headline inflation from the peak reached at end-2022. Inflation-linked bonds represent more than 10% of total debt.

France's eurozone membership entails a compromise on monetary flexibility. In our opinion, the ECB's monetary policy remains credible, reflecting its long-term inflation track record, responses to date in addressing dislocations from private-sector financial flows within the eurozone, and the depth of the eurozone's capital market. Given inflation well above target, we expect the ECB to raise rates, probably until the deposit facility rate reaches 3.50% by the summer (currently at 3.25%), barring further financial market turmoil that could jeopardize prospects for growth and inflation (see "Economic Outlook Eurozone Q2 2023: Rate Rises Weigh On Return To Growth," published March 27, 2023).

We expect lower hydrocarbon prices and strong performance of exports of goods and services in key French sectors, such as aeronautics and tourism, to reduce the current account deficit to 0.7% of GDP in 2026, from a record 2.2% in 2022. France still faces international pressure in terms of its competitiveness, judging by persistent trade deficits. The country's narrow net external debt also remains elevated. Nevertheless, its net external liabilities, of about 25% of GDP, are considerably lower than its narrow net external debt, signifying large external assets, mainly held by the corporate sector. The country has continued to post sizable surpluses on the services (more than 1% of GDP) and income (more than 2% of GDP) balances of its current account for decades.

Lower economic growth, tighter funding conditions, and higher, more-persistent inflation represent headwinds for French banks' asset quality, business prospects, and cost management. Rising interest rates will help increase banks' net interest income over time and provide a larger buffer to accommodate potentially higher credit and operating costs. Still, the benefit for French banks is less immediate than in other systems because their funding costs reprice more quickly than their assets, which typically include long-dated, fixed-rate mortgages originated during previous low-interest-rate periods. Benefits from higher rates may also be constrained by lower credit demand and new credit volumes. That said, large French banks also enjoy good business diversity beyond retail and commercial banking--in insurance, asset management, investment banking, and specialist finance. Their significant base of fee income mitigates pressures on net income. Moreover, fees typically yield relatively stable and recurring through-the-cycle earnings.

Webinar

S&P Global Ratings will host a live interactive webinar on June 5, 2023, at 3:00pm BST/4:00 pm CET to discuss its sovereign rating on France. Please click on the following link to attend: https://event.on24.com/wcc/r/4245111/5537D96CA3082C78B9D1FB271738C9F0?partnerref=MR

Key Statistics

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Ratings Score Snapshot

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings , Oct. 10, 2021
• Criteria | Governments | Sovereigns: Sovereign Rating Methodology , Dec. 18, 2017
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings , April 7, 2017
• General Criteria: Guarantee Criteria , Oct. 21, 2016
• General Criteria: Principles Of Credit Ratings , Feb. 16, 2011
• General Criteria: Methodology: Criteria For Determining Transfer And Convertibility Assessments , May 18, 2009

Related Research

• Sovereign Ratings List, May 17, 2023
• Sovereign Ratings History, May 17, 2023
• Sovereign Ratings Score Snapshot, May 4, 2023
• Default, Transition, and Recovery: 2022 Annual Global Sovereign Default And Rating Transition Study, April 28, 2023
• Sovereign Risk Indicators , April 10, 2023. Interactive version available at http://www.spratings.com/sr
• Economic Outlook Eurozone Q2 2023: Rate Rises Weigh On Return To Growth, March 27, 2023
• Banking Industry Country Risk Assessment: France, Oct. 11, 2022

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision.

After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts.

The committee's assessment of the key rating factors is reflected in the Ratings Score Snapshot above.

The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria And Research').

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