S.&P. Downgrade Deals Blow to French Government

http://www.nytimes.com/2013/11/09/business/international/standard-poors-downgrades-france.html

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PARIS — President François Hollande suffered another setback on Friday, as Standard & Poor’s cut France’s credit rating, saying it did not believe the government’s current policy course would restore growth.

S.& P. cut the credit rating to AA from AA+, arguing that the government’s actions in areas like taxation and the labor market would probably not have much positive impact on the country’s medium-term growth and that “high unemployment is weakening support for further significant fiscal and structural policy measures.”

Markets greeted the news with calm: French bond yields ticked up modestly and the euro was almost unchanged. The rate cut, in a week in which France’s own economic projections were questioned by officials in Brussels, did nothing more than confirm a widely held view that France was making little headway in reviving its economy.

But coming on the same day as a surprisingly robust jobs report in the United States, the downgrade underscored the sharp contrast between a country apparently on the rebound and one — France, second only to Germany as Europe’s biggest economy — struggling to restore the momentum that has been missing since the 2008 financial crisis.

Holger Schmieding, chief economist in London for the German bank Berenberg, said the lack of progress in France, especially compared with turnaround efforts in smaller, weaker euro zone countries like Spain, Portugal, Ireland and Greece, “makes it ever more obvious that France is Europe’s real problem.”

Mr. Schmieding, in a research note, said it was unlikely that France would face a major crisis because its finances were in better shape than most countries’. Instead, France was condemning itself “to further long-term decline,” he said.

The French economy expanded by 0.5 percent in the second quarter of 2013 from the first three months of the year, for an annualized rate of about 2 percent. But unemployment, at 11.1 percent, weighs heavily on growth and on efforts to reduce the budget deficit that are mandated under European Union rules.

Mr. Hollande, a Socialist, has long been seen as a reluctant follower of Europe’s rigorous budget orthodoxy. While he has employed a de facto austerity policy since taking office, he has sought to reduce the deficit spending gap mainly by raising taxes. That approach may be nearing its limits as the electorate questions whether it can afford to pay for the state’s major role in the economy, and Mr. Hollande’s poll ratings are at a record low.

S.& P. said that the outlook for France's credit rating was “stable,” reflecting its expectation that the government would hold debt in check. But S.& P. also said it expected government spending to remain above 56 percent of gross domestic product through 2015, the highest in the 17-nation euro zone, and second only to Denmark among developed nations.

Many economists say that France has no choice but to start seriously addressing the government spending side of the equation, though French officials worry that reducing government demand in the current environment would further depress growth.

As downgrades go, this one does not hold the symbolic value of the one in January 2012, when S.& P. was the first of the major agencies to withdraw France’s coveted AAA rating under former President Nicolas Sarkozy. The other two — Moody’s Investors Service and Fitch Ratings — then followed suit.

Jean-François Copé, president of the center-right UMP party, said the downgrade “points clearly at this government’s inability to cut public spending, stop the rise in unemployment and carry out structural reforms in our country.”

Mr. Hollande nonetheless expressed his determination Friday to continue with his policies, telling a World Bank news conference in Paris, “I will confirm this strategy which is ours, the course of which is mine.”

The S.& P. downgrade was the second embarrassment in the past week for the government. On Tuesday, Olli Rehn, the European Union’s head of economic policy, predicted that joblessness in France would increase until 2015, contradicting French forecasts that showed unemployment peaking this year.

Weakness in France and elsewhere in the euro zone, as well as alarming signs that inflation was declining to levels that might signal the onset of deflation, led the European Central Bank on Thursday to cut its benchmark interest rate to 0.25 percent from 0.5 percent.

Echoing what many government officials have declared lately, Mr. Hollande said his policy rested on the continuation of reforms that had already been undertaken. He has been credited with measures to make the labor market more flexible and has taken up the thorny issue of pension reform. But a planned “fiscal revolution” to rationalize government finance fizzled in September, much as Mr. Sarkozy’s plans before his.

Still, the practical impact of the S.& P. move would appear to be limited. In theory, a lower rating could mean the government’s borrowing costs will rise, something that would be most unwelcome at a time when the government is trying to reduce its deficit to 3 percent of gross domestic product.

On Friday, Mr. Hollande argued that the proof of confidence in the reforms was in the low interest rates investors were demanding to hold French debt. The benchmark French 10-year bond was yielding about 2.23 percent on Friday, up seven-hundredths of a percentage point. That is among the lowest of major economies, and lower than the United States, where the 10-year Treasury was at 2.73 percent. But it remains above the equivalent German government debt, seen as the safest in the euro zone, which was trading to yield 1.7 percent.

Today, just a handful of major nations have a triple-A ranking, the highest, from all three agencies, among them Germany, Norway and Switzerland. The United States lost its AAA rating with S.& P. in August 2011. The ratings agencies, however, have lost much of the standing they once enjoyed, having been widely criticized for enabling the financial engineering that Wall Street used to turn subprime mortgages and other risky loans into top-rated financial products during the global credit bubble.

“The bottom line is that it’s irrelevant in every other respect than pride,” Erik Nielsen, global chief economist at UniCredit in London, said of the downgrade.

France still enjoys an investment-grade rating, Mr. Nielsen said, so the change will not trigger clauses for automatic selling by fund managers whose charters require that they hold only high-quality debt. Nor, he added, does France have the kind of fiscal or current-account imbalances that are “requirements” for a crisis.

Mr. Schmieding said there were even grounds for optimism. He said he was hopeful that as the French political elite became more conscious of how economic stagnation was reducing the country’s weight in European affairs, the policy debate would move toward addressing its problems.