A taste of French ratings fear

There are signs that French leaders are preparing their citizens for a loss of the country's triple-A credit rating – a downgrade that would push the eurozone closer to a deep recession.

Are France’s political leaders softening up voters for an imminent loss of the country’s precious triple-A rating?

That was certainly the impression last week, after senior French government officials launched an unprecedented attack on the British economy, sparking a major diplomatic row between the two countries.

The Bank of France boss, Christian Noyer, was the first to cast doubt on the UK economy. In an interview with the French daily, Le Tlgramme, last Thursday, he said ratings agencies should "start by downgrading the United Kingdom which had bigger deficits, as much debt, higher inflation, less growth than us and where credit is shrinking.”

French Prime Minister Franois Fillon joined in, saying "our British friends (are) even more indebted than we and (have) a higher deficit.” On Friday, France’s finance minister, Franois Baroin, ramped up the attack even further. "It’s true,” he said, "that the economic situation in Britain today is very worrying, and you’d rather be French than British at the moment.”

Not surprisingly, the French attack sparked an angry response from the United Kingdom. On Friday, UK deputy prime minister, Nick Clegg, told Fillon that the comments were "simply unacceptable”. Fillon tried to defuse the situation by saying his comments were aimed at highlighting the inconsistencies in the decisions taken by the ratings agencies, and had not meant to question Britain’s triple-A rating.

There is, of course, some justification in the French position. The UK’s debt level is around the same level as that of France (a little over 80 per cent of GDP), but its deficit is higher (8.4 per cent compared with 5.7 per cent). Growth has ground to a halt in both countries, but inflation in the UK is higher (4.8 per cent compared with 2.7 per cent in France).

But it’s equally clear that the surprise French attack on the United Kingdom was also heavily influenced by domestic concerns. French President Nicolas Sarkozy had long stressed the importance of retaining France’s prized triple-A rating. But he’s been forced to soften his rhetoric in recent weeks, after Standard & Poor’s put 15 of the eurozone’s 17 countries on negative credit watch in early December.

In an interview with the French newspaper, Le Monde, last Monday, Sarkozy argued that if France were to lose its top rating "it would be difficult, but not insurmountable.” Several days later, France’s foreign affairs minister, Alain Jupp, echoed this line, saying that the loss of France’s triple-A rating "wouldn’t be good news, of course, but it would not be a disaster.” He noted that the United States, which S&P stripped of its triple-A rating in August, "can still borrow in the markets on favourable terms.”

So far, French voters appear far from reassured. A recent French opinion poll showed that two-thirds of those interviewed believed that there would be "serious consequences” for the French economy if France were to lose its triple-A rating.

But investors fear that the ripple effects of a French downgrade would spread far beyond Paris. France is the eurozone’s second largest economy, and is seen as a vital bulwark for the eurozone. Together, France and Germany account for close to half the guarantees that backstop the bailout fund, allowing it to raise money to lend to debt-strapped eurozone countries.

If France loses its triple-A rating, markets could form the view that the eurozone simply lacks the financial clout to rescue its debt-laden peripheral economies. And that could push the borrowing costs of Italy and Spain even higher, putting further pressure on their budget deficits, and dragging the eurozone deeper into recession.

InvestSMART FORUM: Come and meet the team

We're loading up the van and going on tour from April to June, with events on the NSW central & north coast, the QLD mid-north coast and in Perth, Adelaide, Melbourne, Sydney and Canberra. Come and meet the team and take home simple strategies that you can use to build an investment portfolio to weather any storm. Book your spot here.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles